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1987 1988
Gross receipts $321,596 $371,994
Cost of goods
sold $257,346 $353,118
Gross profit
percentage 20% 5%
Respondent determined that petitioner had no ending
inventory on December 31, 1987, and, consequently, no beginning
inventory on January 1, 1988. The parties have since stipulated,
however, that petitioner had $10,000 of inventory on January 1,
1988. Respondent also determined that petitioner had $61,305 of
inventory on December 31, 1988.
Discussion
1. Change in Method of Accounting
We must first decide whether respondent abused her
discretion by changing petitioner from the cash method to an
accrual method in order to reflect his inventory, beginning with
the 1988 tax year. We refer to sections 446 and 471 to make our
decision.
Taxable income generally is computed based on the method of
accounting on which the taxpayer regularly keeps his or her
books. Sec. 446(a). The term "method of accounting" includes
the adjustment of any "material item" involving the proper timing
of income and expense. Sec. 1.446-1(e)(2)(ii)(a), Income Tax
Regs. Inventories are a material item.
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