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respondent's method violates the principle of annual accounting.
Of course, under the retailers’ shrinkage method, the retailers’
estimates of shrinkage accruals are also based on information
gathered from prior years, since the retailers’ shrinkage rates
are dependent, in part, on historical data. The distinction,
however, is that the retailers’ shrinkage method utilizes prior
year information as a factor in calculating the current year’s
shrinkage rate, whereas respondent’s method plainly substitutes
yearend shrinkage of the prior year for yearend shrinkage of the
taxable year.
If physical inventories were required to be taken at year's
end, taxable year shrinkage would be known with certainty, and no
estimate of yearend shrinkage would be necessary. Physical
inventories, however, are not required to be taken at year's end.
Sec. 1.471-2(d), Income Tax Regs. Once the Secretary decided not
to require physical inventories at year’s end, see Dayton Hudson
Corp. & Subs. v. Commissioner, 101 T.C. at 467; sec. 1.471-2(d),
Income Tax Regs., and taxpayers began to exercise the privilege
of computing yearend inventories from book inventory records,
estimations of yearend shrinkage became inescapable, whether the
method of estimating yearend shrinkage involves calculation (the
retailers' shrinkage method) or substitution (respondent's
method). Respondent recognizes that fact. Respondent's
position, however, is that, unless a taxpayer can demonstrate the
accuracy of his calculation of yearend shrinkage, the taxpayer
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