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1990, and, to arrive at royalty expense for income tax purposes,
Random House increased financial statement royalty expense by
$1,903,000 for 1989, and $1,048,077 for 1990.4 Respondent
disputes only the latter adjustment to Random House’s financial
statement income.
The parties disagree on whether the annual adjustments to the
royalty reserve for financial statement purposes were the same as
the annual amounts withheld from the royalties paid to authors as
a "reasonable reserve for returns" (reasonable reserve for
returns). Petitioner alleges that the financial statement reserve
for returns and royalty reserve were determined on a completely
different basis than the reasonable reserve for returns withheld
from the royalty payments to authors. The former were Generally
Accepted Accounting Principles (GAAP) reserves whereas the latter
was determined on an author-by-author basis as a cash management
device, and was intended to protect Random House against the
possibility of a payment of royalties to an author in one
accounting period and the company’s subsequent inability to
recover royalties from that author (based upon returns) in a later
accounting period. According to petitioner, the amount of
royalties actually withheld from authors is not known,
4 In determining taxable income and deductible royalty
expense attributable to the sale of soft cover books, Random
House did take into account subsequent year returns to the extent
permitted by sec. 458.
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