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D. Respondent's Method
Respondent would permit the Divisions to account for losses
from shrinkage factors only when such losses are verified by
physical inventories (respondent's method). Respondent claims
that that “method is nothing more than application of the
principle that taxpayers may not reduce income by unverified
losses or expenditures, or unreliable estimates”. Upon closer
analysis, we conclude that respondent's method essentially
estimates yearend shrinkage for the taxable year based on yearend
shrinkage for the prior taxable year.
Respondent's method would adjust the Divisions' book
inventories by disallowing any shrinkage accrual. The Divisions'
cost of goods sold, as determined by book inventories, would
essentially include shrinkage for inventory cycles beginning in
the prior taxable year and ending in the taxable year and not any
portion of the shrinkage determined for inventory cycles
beginning within the taxable year and ending in the next taxable
year (i.e., yearend shrinkage). In sum, the Divisions’ cost of
goods sold for a taxable year that included cross-year inventory
cycles would include shrinkage accurately measured (i.e.,
verifiable) for some period other than that taxable year (i.e.,
an inventory year).
If it is assumed that there is yearend shrinkage, then,
unless the amount of yearend shrinkage for the taxable year is
identical to the amount of yearend shrinkage for the previous
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