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OPINION
I. Introduction
Petitioner's principal business activities are the operation
of department stores. We are concerned here with petitioner's
Target division (Target) and its Dayton's division (Dayton's)
(together, the Divisions).
During the taxable year in issue, the Divisions used cycle
counting to conduct physical inventories of merchandise. Under
the cycle counting method, physical inventories were taken in
rotation, at the various stores or departments within stores,
throughout the year. Also, the Divisions maintained book
inventory records from which inventories could be determined
without a physical count. The Divisions estimated losses from
shrinkage factors (e.g., theft and errors in billing) during the
physical-to-yearend period (yearend shrinkage) and made an
accrual of that estimate (shrinkage accrual). That practice had
the effect of increasing cost of goods sold and decreasing gross
income.
Respondent disallowed the Divisions’ shrinkage accruals, and
we must determine whether that disallowance is an abuse of
discretion.
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