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Neither of these analyses properly evaluates the stub period
estimate.
By comparing the unadjusted results from physical
inventories to the adjusted book amounts, the verification
provided by the physical counts helps test the overall accuracy
of petitioners' entire method of accounting for shrinkage, as it
affects petitioners' inventory balances and annual determination
of income. As shown in the above table, petitioners' shrinkage
adjustment to inventories for each taxable year reasonably
represents the amount of shrinkage verified by physical counts
taken in the same year. In the 1986 taxable year, the numbers
are the same. In the 1983 and 1985 taxable years, the numbers
are within .0001 percent. In both 1983 and 1985, the amounts
booked were less than the amount verified by the physical counts.
Only in the 1984 taxable year did the amount booked exceed the
amount verified by physical count, and that overstatement was
only .0005 percent. These modest differences indicate that
petitioners' method of accounting for shrinkage produced
reasonable results. Respondent's determination, by contrast,
would have petitioners omit shrinkage estimates for the subject
years in the respective amounts of $33.6 million, $40.2 million,
$62.1 million, and $67.9 million.
The second way in which the reasonableness of petitioners'
shrinkage estimates can be seen is by understanding the
relationship between shrinkage and sales. Respondent relies on
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