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must choose between yearend physical inventories and respondent's
substitution method of accounting for yearend shrinkage.
Respondent also recognizes, however, that, under the logic of
Dayton Hudson, if petitioner demonstrates the accuracy of the
retailers' shrinkage method, that method does clearly reflect
income. On brief, respondent states:
The crucial issue in determining whether
Petitioner’s methods of estimating shrinkage clearly
reflected income is whether the methods were designed
to produce accurate results. Clear reflection of
income means that income should be reflected with as
much accuracy as standard methods of accounting
practice permit. [Citing Caldwell v. Commissioner, 202
F.2d 112, 115 (2d Cir. 1953).]
We must determine the accuracy of the retailers' shrinkage method
to determine whether it clearly reflects income.
I. Accuracy
Absolute accuracy is not required. Indeed, respondent as
much as concedes that absolute accuracy is not required by
stating that clear reflection means reflection with as much
accuracy as standard methods of accounting practice permit.
Also, absolute accuracy is not the standard demanded of book
inventories by section 1.471-2(d), Income Tax Regs. That section
explicitly states that balances shown by book inventories “should
be verified by physical inventories at reasonable intervals and
adjusted to conform therewith.” (Emphasis added.) Both
verification and adjustment would be unnecessary if only absolute
accuracy were acceptable. Finally, section 1.446-1(c)(1)(ii)(A),
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