- 31 -
November 1, 1991, petitioner used the cash method of accounting
for tax purposes. Effective November 1, 1991, petitioner changed
its method of accounting for tax purposes from the cash method to
the accrual method. As a result of the change in accounting
method, petitioner realized a section 481(a) adjustment of
$1,637,156 and included $409,289 of the adjustment in income for
each of the 4 taxable years ending October 31, 1992 through 1995.
Thus, the section 481(a) adjustment affected the taxable year
1995 and artificially increased petitioner's income by $409,289
for that year.
Mr. Reilly's second analysis estimated the reasonableness of
petitioner's executive compensation by calculating petitioner's
residual economic income after a fair return on the total fair
market value of the stockholders' invested capital. In order to
assess the reasonableness of executive compensation under this
method, Mr. Reilly allocated to management all the profits in
excess of a fair return on the total fair market value of the
stockholders' invested capital.
Mr. Reilly estimated that, over the period from 1987 to
1996, a fair before-tax annual rate of return on petitioner's
common stock would vary year to year from 26.0 percent to 32.7
percent. Mr. Reilly's estimated fair return was 28.2 percent for
1995 and 26 percent for 1996. Mr. Reilly calculated an estimated
value of invested capital in each year and increased the value by
Page: Previous 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 NextLast modified: May 25, 2011