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Both Dr. LaRue and Mr. Sutherland concede, however, that
respondent’s adjustments--which disallow the retailers' shrinkage
accruals--would produce exactly the same types of errors if there
were undetected yearend shrinkage. Indeed, the magnitude of such
errors under respondent’s method might well be greater because of
respondent’s failure to account for trends or other factors
applicable to the taxable year.
In any event, respondent’s proposed adjustments will not
eliminate the flaws perceived by respondent’s experts. It
appears that only the practice of yearend physical inventories at
all stores could eliminate such errors. That, however, would not
be practical, nor is it required by the regulations. See sec.
1.471-2(d), Income Tax Regs.
G. Retailers' Shrinkage Method Compared to Respondent's
Method
Respondent's method would permit the retailers to account
for losses from shrinkage factors only when such losses are
verified by physical inventories. Respondent claims that her
"method is nothing more than the application of the principle
that taxpayers may not reduce income by unverified losses or
expenditures, or unreliable estimates." Respondent states that
"any alternative method of estimating shrinkage imposed by
Respondent would have been wholly arbitrary since it would not
clearly reflect income."
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