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which is postponed for 15 years. The depreciated value of the building at the termination of the period of the lease will be approximately $20,000– that is, cost less depreciation sustained. The income of A, then, is the discounted value of $20,000 receivable at the end of 15 years. If market value reflects intrinsic value, this amount should equal the difference between the value of the land free from the lease without the buildings and the value of the land subject to the lease with the building. However, any other evidence available should be considered in determining this present worth to the taxpayer of the legal title to the encumbered building. Since A has included in income only the depreciated value of the building, he is entitled to a depreciation deduction with respect to such building only for the years after the termination of the period of the lease when A has come into possession. This depreciation deduction to which A is entitled for 1935 and subsequent years should be computed on a basis of the estimated remaining life of the building and a "cost" value equal to the market value placed on the encumbered building by in the year of its erection, i. e., the annual depreciation deduction for 1935 and subsequent years will be the quotient obtained by dividing (a) the value of the improvements to A as determined by him when the same completed became part of the realty, by (b) the number of years in the estimated remaining life of the improvements from the termination of the lease.

In any case in which the term of the lease is greater than the estimated life of the improvement no income should be accounted for by the lessor at the time of the passage of title. Also if the improvements will have no value at the termination of the lease, as is often the case in mining leases, no income is realized by the lessor. SECTION 214(a) 8, ARTICLE 163: Depreciation

O. D. 818 of intangible property. In the case of liquor dealers the useful life of whose intangibles such as good will, trade-marks and trade brands, was definitely limited as a result of prohibition legislation, an allowance for obsolescence is permissible. However, in the case of dealers who continued in a similar trade or business, the useful life of such intangibles is not definitely limited, although the profits may have been reduced. Therefore, liquor dealers who continued in a similar trade or business can not obtain a deduction under section 214(a) 8 on account of obsolescence of their good will, trademarks and trade brands. SECTION 326, ARTICLE 841: Surplus and undivided

A. R. R. 394 profits : limitation of additions to surplus account.

Recommended that a corporation which issued bonds at a discount in January, 1900, and elected then to charge such discount to profit and loss for the year of issue and the next two succeeding years, may not now revise its accounts and file amended returns for the purpose of reinstating to invested capital the unexpired portion of such discount and claiming as a deduction from income that portion applicable to each year.

It appears from the records that the M Company issued bonds on January 1, 1900, to the amount of 70x dollars at a discount of 7x dollars and charged such discount to profit and loss in 1900, 1901, and 1902.

The accountants writing in behalf of the corporation stated that it was their understanding that for the purpose of computing net income the case was covered by article 544(3) (a) of regulations 45. The M Company in its appeal contends, in effect, that it did not follow good accounting practice in charging off the discount in question to profit and loss during the years 1900, 1901, and 1902; that recognized accounting, authorities, some of whom are named and quoted, hold that discount on bonds issued should be spread over the term of the bonds and the installments thereof charged against income each year, and that, under article 544, it did not

have an option of treating all of such discount as interest expense at the date of issuance of the bonds. Article 544 (3) (a) of regulations 45, reads:

If bonds are issued by a corporation at a discount, the net amount of such discount is deductible as interest and should be prorated or amortized over the life of the bonds.

The unit, in its reply of June 30, 1920, contended that article 544 (3) (a) must be considered in connection with article 841, which latter article, bearing the caption "Surplus and undivided profits: limitation of additions to surplus account,” provides, in part, that deductions which have been taken from income and which are as a matter of good accounting to some extent optional, such as experimental expenses, patent litigation, development of good will through advertising or otherwise, can not be reinstated in surplus, as in such cases it is considered that the corporation has exercised a binding option in deducting such expenses from income, and an election of this sort which was made concurrently with the transaction can not now be revised and amended returns in respect thereto can not be accepted.

The solicitor of internal revenue, in a memorandum dated May 13, 1919, commenting on a ruling in a case similar to the one under consideration, stated :

It appears that the corporation in this case had an option as to the method it would adopt in handling entries of the discount on the bonds which it issued. Two methods were available:

First. To treat the discount as interest paid in advance to be amortized over the life of the bonds.

Second. To charge the discount as a loss in its profit and loss account.

The corporation exercised its option by adopting the second method. It did so apparently to lessen its income for the year the transaction took place. It now seeks to adopt the first method and desires to amend its 1917 return accordingly. The effect of this procedure would be that the discount item would be taken from the losses (profit and loss account), thus diminishing the losses and thereby increasing its surplus account, and indirectly its invested capital.

Where a corporation has exercised an option as to accounting practice and such option was concurrent with the transaction; amended returns are not permissible. See article 841 of regulations 45.

While the committee is in accord with the contention of the M Company that it did not follow the more generally approved accounting method in charging off the discount on its bonds of January 1, 1900, as it did, that fact alone does not entitle it now to adopt another method and adjust its accounts for the purpose of filing amended income and profits tax returns. There were at the time said bonds were issued no income-tax regulations prescribing a method to be followed in the treatment of bond discount. It was entirely optional with the taxpayer as to the method it would adopt in handling entries of discount on bonds issued, and inasmuch as that option was exercised at the time the bonds were issued a different method of accounting can not now, in the opinion of the committee, be adopted for tax purposes, which opinion is sustained by the decision in the case of the C. & A. Railroad v. United States Court of Claims (see article 149, regulations 33, revised, issued under the provisions of the revenue act of 1916, as amended by the revenue act of 1917).

The committee, therefore, recommends that the ruling of the unit be sustained.

Students' Department

EDITED BY H. A. FINNEY

AMERICAN INSTITUTE EXAMINATIONS, NOVEMBER, 1920

In regard to the following attempt to present the correct solutions to the questions asked in the examination held by the American Institute of Accountants in November, 1920, the reader is cautioned against accepting the solutions as official. They have not been seen by the examiners-still less endorsed by them.

COMMERCIAL LAW
ANSWERED BY John C. TEEVAN*

NEGOTIABLE INSTRUMENTS

Answer three of the following four questions: 1. Is the following a negotiable instrument?

Boston, Mass., July 1, 1920. One year after date, for value received, the Y. Z. corporation promises to pay to the order of Adam Brown three thousand dollars with interest at the office of the Y. Z. corporation, Boston, Mass., or, at the option of the holder hereof, upon the surrender of this note to issue to the holder hereof in lieu thereof thirty shares of the preferred stock of said Y. Z. corporation and to pay to the holder hereof in cash the interest then due upon said sum. The Y. Z. corpora

tion, by Y. Z., President. Answer:

This instrument is a negotiable promissory note. It is an unconditional promise to pay a sum certain in money at a fixed future time to the payee's order. The inclusion of a promise to issue stock to the holder of the note, at his option, in lieu of the sum of three thousand dollars with interest, does not prevent the maker's promise from being construed as being a promise to pay a sum certain in money. The option is with the holder, not the maker. This point is directly covered by section 5 of the negotiable instruments law which provides that "the negotiable character of an instrument is not affected by a provision ... which gives the holder an election to require something to be done in lieu of payment in money." Nor does the fact that the payment of interest is promised, and no rate stipulated, render the sum uncertain. Section 2 of the negotiable instruments law states that “the sum payable is a sum certain ... although it is to be paid with interest.” In the absence of a stipulated rate the legal rate of interest applies. 2. What is the effect of endorsement of a negotiable instrument

(a) by an infant?

(b) without consideration, by a corporation? Answer:

(a) Section 22 of the negotiable instruments law provides that the endorsement of a negotiable instrument by an infant passes the property

* Instructor in business law, Northwestern University school of commerce.

therein, i. e., passes the title to the transferee or endorsee. Such endorsee has the right to enforce payment from all parties prior to the infant endorser. In other words the prior parties cannot avail themselves of the incapacity of the infant. But the infant's endorsee is not a bona fide holder as against the infant. The latter may disaffirm (as he may any contract except for necessaries) and thereafter there can be no recovery by his endorsee or any subsequent endorsee. Payment by the maker to the endorsee does not protect the maker. Once the infant has disaffirmed he may recover on the instrument. Briefly, the endorsement of an infant passes title, but the infant may disaffirm.

(b) The endorsee gets a good title to the instrument, but the corporation incurs no liability thereon as an endorser. Section 22 of the negotiable instruments law provides that "the endorsement

of the instrument by a corporation ... passes the property therein, notwithstanding that from want of capacity the corporation may incur no liability thereon."

3. A sold his automobile to B, warranting it to be a 1918 model in good mechanical condition. B gave A his note in payment of the purchase price, of which note C became the holder in due course. B, after a few days, found that the automobile was a 1917 model and in such defective condition that its actual value was but a small proportion of the purchase price paid by him, of all of which X had knowledge. X subsequently purchased the note from C. Could he enforce the note against B? Answer:

X derived his title to the note from C, who was a holder in due course. Assuming that X was not a party to the fraud practised by A on B, the maker, his (X's) knowledge of the fraud is immaterial. X takes the same title as his transferor, C, had. C being a holder in due course, A's fraud could not be raised as a defense by B against C. X, being the transferee of C, stands exactly in the same position as C and can enforce payment of the note by B. This point is covered by section 58 of the negotiable instruments law.

4. How may a "qualified endorsement be made and what is the effect of such an endorsement? Answer:

A qualified endorsement is made by adding the words "without recourse" to the signature of the endorser. This qualification has no effect on the negotiability of the instrument, and so the instrument may be negotiated subsequently with the same freedom as though not so endorsed. The contract of a qualified endorser is covered by section 65 of the negotiable instruments law, under which such endorser warrants (1) that the instrument is genuine; (2) that he has a good title to the instrument; (3) the capacity of all prior parties; and (4) that he knows of nothing which would impair the validity of the instrument or render it valueless. Thus, for example, he does not warrant that the maker is solvent, but if the maker were an infant or otherwise incapacitated he would be liable under warranty number 3.

CONTRACTS

Answer both the following questions: 5. A entered into the following agreement with the R. S. Cement Company :

“Memorandum of agreement made this 6th day of July, 1905, between A, first party, and R. S. Cement Company, second party, to wit, first party agrees to give the ‘R. S.' brand cement the preference in his sales of cement for the year 1905, and in consideration thereof, second party agrees to sell said brand of cement to the first party during the year 1905 at the price of 95 cents a bbl. f. o. b. Haverstraw, New York.”

A ordered several shipments of cement which were duly delivered and paid for. Subsequently the market price for cement rose and the cement company notified A that it would furnish no more cement under the agreement. A then purchased his cement elsewhere during the remainder of the year at higher market prices, and he sought to recover from the cement company as damages the difference between the cost of the cement purchased by him at the prevailing market price and what the cement would have cost at the price provided in the agreement. Could he recover ? Answer:

A cannot recover. This agreement is void, and so without legal effect, on three grounds: (1) A's promise is uncertain and indefinite. No limit is placed on the amount of cement that A might order during the year. Nor is there any method provided for in the agreement by which the quantity can be made certain. (2) The agreement lacks mutuality. A is not bound thereunder to sell to his customers or order from the company any cement, but the R. S. Cement Co. is bound to sell to.A. The rule is that both parties to a contract must be bound, or neither is bound. (3) There is no consideration on the part of A. He is under no obligation to purchase any cement from the company and has therefore sustained no legal detriment. 6. Define

(1) a joint contract.
(2) a joint and several contract, and point out the rights of the

respective parties under each. Answer:

(1) A joint contract is one in which a promise is made by two or more promisors, who, by the provisions of the contract, are jointly bound to carry out such promise, or one in which a promise is made to two or more promisees who are jointly, but not severally, entitled to require performance of such promise. In the case of the failure of joint promisors to fulfill their joint obligation, the promisee must sue them all jointly. If the promisee releases one joint promisor, he thereby releases all the other joint promisors. If one joint promisor dies, the liability survives to the surviving joint promisor or promisors. In the case of a breach of a promise made to joint promisees, such joint promisees must sue the promisor jointly. They cannot bring separate suits against him. If one joint promisee dies, the right of action is in the survivors.

(2) A joint and several contract is one by which, not only all the promisors are liable together or jointly, but each promisor is liable severally. In other words, the promisee in a joint and several contract may choose to hold all the promisors jointly bound to fulfill their obligations to

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