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shrinkage are correlated, evidence of an identity between actual
and estimated shrinkage rates for an inventory period is no
evidence that the shrinkage estimation rate for the inventory
period is accurate for that portion of a taxable year that falls
within (but is not identical to) the inventory period.11 We
rejected above a general correlation between sales and shrinkage
based on the 10-year correlation analysis. In addition,
Dr. Seago derived only an R2 of 0.367 from his disaggregated
analysis of Target stores during the taxable years ending in 1980
through 1989. In sum, we cannot accept Dr. Seago's assumption of
a strong correlation between sales and shrinkage, and, therefore,
Dr. Seago's sales percentage shrinkage analyses do not persuade
us that the Divisions' shrinkage methods clearly reflect income.
11 The requirement of the assumption that sales and shrinkage
are correlated is illustrated by the following example. Assume
that X Co. (1) is a calendar year taxpayer; (2) has an inventory
period from Apr. 1 to Mar. 31; (3) has no sales from Jan. 1,
1990, to Mar. 31, 1990, and $1 of shrinkage for that period;
(4) has $100 of sales from Apr. 1, 1990, to Dec. 31, 1990, and no
shrinkage for that period; (5) has no sales from Jan. 1, 1991, to
Mar. 31, 1991, and $2 of shrinkage for that period; and
(6) accrued shrinkage at a rate of 2 percent of sales for all
relevant periods. Upon the physical inventory on Mar. 31, 1991,
X Co.'s records would indicate $100 of sales and $2 of shrinkage
during the inventory period. Thus, verified shrinkage of
2 percent of sales would correspond to accrued shrinkage of
2 percent of sales. The identity of results for the inventory
period does not correspond to an identity of results for the
taxable year because actual shrinkage for the taxable year was
1 percent of sales. That discrepancy exists because the example
did not assume that sales and shrinkage are correlated.
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