Photo-Sonics, Inc. v. Commissioner of Internal Revenue

We face a petition for review of a Tax Court decision upholding the assessment of a deficiency in the payment of income taxes. The decision is reported at 42 T.C. 926 (1964). The petitioning taxpayer properly invokes our jurisdiction under sections 7482 and 7483 of the Internal Revenue Code of 1954.

The controversy stems from taxpayer’s method of accounting for its inventory of goods which it manufactured. Under the method, generally described as “prime costing” or “prime cost”, only the cost of direct labor and materials were allocated to inventory value. No portion of factory-overhead expense, variable or fixed, was included.

The key to validity of an accounting method is, in accounting terms, a matching of costs and revenues and, in terms of the taxing statute, a clear reflection of income. Int.Rev.Code of 1954, §§ 446,471. The Government urges that, just as labor and materials cannot be expensed in the year in which such expenses are incurred without giving due regard to whether the manufactured product remains on hand, factory-overhead expenses which constitute a portion of the cost of unsold manufactured products cannot be expensed as they are incurred but rather should be…