Kaps Warehouse, Inc. - Page 29

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                  Petitioner's income taxes for fiscal years 1991 and 1992 were                       
            substantially understated as a result of (1) giving rebates to its                        
            related entities for which it has shown no economic justification                         
            other than to avoid taxation, and (2) writing down its ending                             
            inventory in the respective amounts of $160,000 and $415,000 in                           
            fiscal years 1991 and 1992.  Our discussion in Issue 1 leaves no                          
            doubt that petitioner had no reasonable basis or substantial                              
            authority for its position of giving the rebates. We will                                 
            hereinafter discuss whether petitioner was justified in writing                           
            down its ending inventory.                                                                
                  Petitioner maintained a perpetual inventory system.  On a                           
            daily basis, purchase invoice amounts  were  plugged  into                                
            petitioner's computer and sales were taken off on a daily sales                           
            sheet, leaving an inventory balance.  Each month, if amounts sold                         
            were greater than purchases, ending inventory would be lower than                         
            the previous month.  If amounts sold were less than purchases,                            
            ending inventory would be higher than the previous month.  At                             
            yearend, petitioner relied on its perpetual inventory system and                          
            took no physical inventory of goods on hand.  As new inventory was                        
            purchased, petitioner updated its book inventory cost per unit on                         
            the basis of the most recent invoice price from suppliers.                                
            Petitioner had no significant amounts of obsolete inventory in                            
            stock in the years at issue.  If inventory became obsolete,                               
            petitioner's suppliers would normally accept the inventory in                             

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