Wal-Mart Stores, Inc. and Subsidiaries - Page 9

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          the year, see sec. 1.472-2, Income Tax Regs. At the end of each             
          month, Wal-Mart applied a cost complement to convert its                    
          inventory balances from retail to deemed cost.  Wal-Mart's                  
          internal monthly financial statements reported inventory                    
          shrinkage (both estimated and verified) as an increase to cost of           
          goods sold.                                                                 
                Sam's did not use the retail method.  Sam's used the First            
          In, First Out method of identifying items in ending inventory.              
                C.  Cycle Counting                                                    
                Petitioners did not count the actual yearend inventory at             
          each of their stores.  They counted each store's inventory at               
          various times during the year (referred to as cycle counting).              
          The use of cycle counting, and the absence of a physical count at           
          yearend, is common in petitioners' industry.  Petitioners used              
          this technique during the subject years because they were unable            
          to physically count the inventories at all of their stores/clubs            
          on the last day of the taxable year.  Cycle counting was also               
          advantageous to them because it was less disruptive to business             
          operations, and it allowed management to receive information                
          throughout the year on the effectiveness of internal operations             
          and changes in external behavior.  The continuous flow of                   
          information facilitated management's response to shrinkage trends           
          on a timely basis.                                                          
                During the subject years, petitioners' independent                    
          auditors were Ernst & Young (E&Y).  E&Y advised Wal-Mart that it            




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