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verified by physical inventories at reasonable
intervals and adjusted to conform therewith.
III. Prior Proceedings
Previously, on respondent's motion for summary judgment, we
addressed one of the issues presented in this case. In Dayton
Hudson Corp. & Subs. v. Commissioner, 101 T.C. 462 (1993), we
held that section 1.471-(2)(d), Income Tax Regs., as a matter of
law, does not prohibit petitioner from making a shrinkage accrual
in computing book inventories. We acknowledged, however, that
respondent might yet argue that petitioner's accounting system,
including the making of shrinkage accruals, is not “sound” within
the meaning of the regulations, or fails to clearly reflect
income. Id. at 468.
Respondent acknowledges our holding in the earlier opinion,
but does not agree that it is correct. We adhere to that
holding.
IV. Are the Divisions' Systems of Accounting for Inventories,
Including the Making of Shrinkage Accruals, Sound?
Because the Divisions used cycle counting to conduct
physical inventories of merchandise, and generally no count was
taken at yearend, the Divisions necessarily had to maintain book
inventory records to determine yearend inventories for purposes
of computing cost of goods sold. Those book inventories included
an entry for shrinkage accrual. We must determine whether those
book inventories were maintained in accordance with a “sound
accounting system”. Sec. 1.471-(2)(d), Income Tax Regs.
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