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inventories, the taxpayer made a shrinkage accrual. In the
Dayton Hudson case, which was before us on the Commissioner’s
motion for summary judgment, we held that section 1.471-2(d),
Income Tax Regs., as a matter of law, does not prohibit making a
shrinkage accrual in computing book inventories. We
acknowledged, however, that the Commissioner might yet argue that
the taxpayer’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.
Here, respondent acknowledges our holding in the Dayton
Hudson case, but she does not agree that it is correct. We
adhere to that holding.
IV. Are the Retailers’ Systems of Accounting for Inventories,
Including the Use of Shrinkage Accruals, Sound?
Because the retailers used cycle counting to conduct
physical inventories of merchandise, and no count was taken at
year’s end, the retailers 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.
The question of what constitutes a “sound accounting system”
under section 1.471-2(d), Income Tax Regs., has not been answered
by the courts. Section 1.471-2(a), Income Tax Regs., however,
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