Satyanarayana Rao, J.
1. The question referred to this court for decision is a simple one, namely,
'whether the valuation of the closing stock is to be made on the basis adopted by the assessee company.'
To bring out the method adopted by the asses-see for valuating the closing stock a simple illustration may be given. Suppose he had purchased goods at Rs. 500 cost price and if such goods remained unsold at the end of the accounting year, applying the well known principle of commercial accountancy, the assessee adopted the market value (say for example Rs. 300) of the goods on that date as it was lower of the two values, namely, the market value and the cost price. Having done that in valuing of the closing stock he correctly adopted that value of Rs. 300 as the value of the opening stock for the succeeding year. But at the end of the succeeding accounting year instead of again applying the principle, that he should have valued the closing stock either at the market value or the cost price whichever is lower, adopted the same value of Rs. 300 at which the opening stock was valued, when the market price was say Rs. 400. Here it must be mentioned that the market value means
'market value at the commencement of the year when the opening stock has to be valued and at the close of the year when the closing stock has to be valued and not any intermediate valuation.'
The method of valuation of the closing stock adopted by the assessee was objected to by the Incometax authorities and their decision was upheld by the Appellate tribunal. The assessee adopted the mercantile system in maintaining his accounts, and the only question is whether he followed correctly the well-established principles of accountancy in making up his accounts. It is a long established principle of accountancy that in order to arrive at true profits of a business the closing stock during that period should be valued either at the market value or at cost price whichever is lower, at the option of the trader. The principle underlying this, is to provide a reserve for the loss which he is likely to incur during the period. By giving the option to adopt the lower of the two valuations the trader is protected from being taxed in respect of profits which he did not actually earn. Profits always represent the surplus of the receipts over the cost price including expenditure. The cost is always taken and understood to be the original cost. Applying this principle in different years at each stage the market value or the cost of the stock must be considered and the trader has to choose between the two valuations to make out and adopt whichever is to his advantage.
What is now urged in support of the contention that the opening stock and the closing stock in the accounting year could be valued at the same figure, is that the value of the opening stock represents really the replacement value of the goods at that time and therefore, it represents the cost price of the stock. In valuing the closing stock as under the rule already stated he has got the option to adopt either the cost price or the market rate whichever is lower; it is claimed that he is entitled to adopt this notional cost price because it is lower than the market rate. In the illustration given, the sum of Rs. 300 the value of the opening stock during the accounting year is undoubtedly lower than the market value which was Rs. 400. In support of this contention no authority has been cited except the opinion of a text book writer, Mr. Montgomery, whose opinion was based upon certain trading regulations having statutory force and obtaining in America. There are no such rules in India and in Great Britain. The learned advocate is not able to cite any opinion of any text book writer of England on the subject in support of his contention. When the assessee was allowed to set off in the previous accounting year the loss of Rs. 200 incurred against the profits earned he was allowed to create a reserve from the profits to cover the loss of Rs. 200. In the succeeding year when the market price was Rs. 400 and the cost of the goods was Rs. 500 the reserve of Rs. 200 already allowed was not justified as the loss in the succeeding year was reduced to Rs. 100. In reality in respect of this Rs. 100, he was not being called upon to pay tax as profits arising by the sale of the goods but is called upon to bring back from out of the reserve a sum of Rs. 100 in respect of which he did not pay tax in the previous year. At no stage when this principle is applied would he be called upon to pay tax on profits which he did not actually earn for if the value of the goods appreciated to Rs. 600 the difference of Rs. 100 cannot be treated as profits and would not be treated because the assessee has the option of choosing between the cost price and the market price whichever is lower. In the illustration if the market price goes to Rs. 600 he could value the closing stock at Rs. 500 the cost price, and no question of profits being taxed before they are earned would arise.
The rule of accountancy adopted all over England and as also adopted in India is to construe the cost price as 'original cost price' and not a notional cost price and liberty should be given to the assessee to adopt either the original cost price or the market value. There is no authority in support of the position that the cost price means notional cost price. On the contrary decisions in which the application of the rule was considered are against this contention, In the decision in -- 'Commr. of Income-tax and Excess Profits tax, Madras v. Messrs, Chari and Ram, Madura : 17ITR1(Mad) , the question that arose for consideration was whether the assessee was bound to value different kinds of goods at the average cost and also value them at the average market price and then adopt the lower of the two or whether he was entitled when the prices of the goods varied to adopt in respect of such of the goods whose cost price was higher than the average market value and in respect of others the average of the cost price where the cost price was lower than the average market value. The answer given by this court was that the latter view is correct and that the department was not entitled to insist that the assessee should adopt the former method. This court examined the decisions in England in which the scope of this principle of accountancy was fully considered. The same view was taken in England in the case -- 'Inland Revenue Commissioners v. Cock Russell & Co. Ltd.', 1949 2 A11 E. R. 889 and in -- 'Commr. of Income-tax v. Chengalvaraya Chetti', 2 I. T. C. 14: 48 Mad 836, the assessee adopted some novel method of Valuing the opening stock. With a view to set off loss against profits in the first year, the assessee adopted the ccst price as the price of the opening stock and the market value as the price of the closing stock of that year. In the succeeding year, however, instead of taking the value of the closing stock as the value of the opening stock he again adopted the cost price as the value of the opening stock for the succeeding year. This, it was pointed out, was not warranted and was opposed to principles of commercial accountancy and the rule that in arriving at trading profits the trader has the option of choosing either the market value or the cost price whichever is lower cannot be applied in the manner in which it was done by the assessee in that case. These decisions, in our opinion, clearly point to the conclusion that the method which the assessee has adopted in valuing the closing stock in the present case is not supported either on principle or authority. In these circumstances the question referred to us must be answered in the negative and against the assessee. As the assessee has failed he must pay the costs of the respondent which we fix at Rs. 250.