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projected income of $50 million for K&H. K&H was not directly
involved in the research and development of the vending machine.
K&H determined the amount of partial worthlessness of the
advances made to Snacks each year by comparing the prior year’s
ending advance balance with Snacks’ cumulative losses to arrive
at a ratio. The resulting ratio was then applied to the prior
year’s ending advance balance to arrive at the claimed writeoff.
Snacks’ net worth as of July 31, 1990, 1991, 1992, 1993, and 1994
was a negative $1,244,172, $2,107,158, $2,571,348, $3,019,739,
and $3,126,138, respectively, each caused by an excess of
liabilities over assets. For its fiscal years ended April 27,
1991, and April 25, 1992, K&H claimed that the advances to Snacks
had become partially worthless (a bad debt) and deducted the
amounts of $579,607 and $461,970, respectively. Respondent, in
the notice of deficiency, determined that the claimed bad debt
deductions were not allowable.
K&H advanced Snacks more than $700,000 through April 1990
and additional amounts of $320,000 and $260,000 during the fiscal
years ended April 1991 and 1992. For the period ended December
31, 1993, K&H, based on the accountant’s advice, sold to the
accountant $650,000 of the notes for $1,000 in an attempt to “fix
the time and amount of the loss.” Respondent determined that the
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