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K. Did Respondent Abuse Her Discretion in Determining That
the Retailers’ Shrinkage Method Does Not Clearly Reflect
Income and That Respondent’s Method Does Clearly Reflect
Income?
We have found that the retailers’ shrinkage method was
applied consistently from year to year. We have also found that,
assuming either a sales-based or time-based allocation of losses
from shrinkage factors, the retailers’ shrinkage method is more
accurate than respondent’s method.
We consider whether respondent abused her discretion in
determining that the retailers' shrinkage method does not clearly
reflect income in light of section 1.471-2(d), Income Tax Regs.,
which allows for book inventories whose balances are verified by
physical inventories conducted at reasonable intervals.
Respondent has not challenged the intervals at which the
retailers verified their book inventories by physical count.
Indeed, during each of the years in question, the KFS division
and Florida Choice conducted an average of 2 or more physical
inventories a store, and Superx conducted an average of 1.5 or
more physical inventories a store. The retailers used cycle
counting to take physical inventories. Throughout the year,
cycles ended and physical inventories were taken. On average,
the physical-to-yearend period was no more than 3 months for both
the KFS division and Florida Choice. For Superx, the average
length of the physical-to-yearend period was 4 months. Of
course, since estimates were involved, there were bound to be
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