Adjusting Entry For Inventory Shrinkage

Inventory Shrinkage

The difference betwixt the actual concrete inventory and the corporeality on the company's balance canvas

What is Inventory Shrinkage?

Inventory shrinkage occurs when the number of products in stock are fewer than those recorded on the inventory list. The discrepancy may occur due to clerical errors, goods being damaged or lost, or theft from the indicate of purchase from a supplier to the point of auction.

Inventory Shrinkage

When a business discovers a shrinkage in its inventory, any discrepancies should exist accounted for to reconcile the records with the physical inventory count. The matching principle requires that inventory shrinkage should be recorded every bit an expense in the financial menstruation in which it occurred to lucifer it against the revenues for that year. A shrinkage expense account will be recorded under the Cost of Goods Sold (COGS) account.

How to Summate Inventory Shrinkage?

A concern may determine the value of the shrinkage past physically counting the stock and determining its value, and and then subtracting the value of the stock from the inventory cost listed in the bookkeeping records. Divide the departure by the amount of stock recorded in the accounting books to get the percentage of inventory shrinkage.

For example, assume that company ABC owns $100,000 of inventory recorded in its accounting books for a specific bookkeeping menstruation. If the company conducts stock inventory and finds the stock on hand to be $95,000, the amount of stock shrinkage is $5,000 ($100,000 – $95,000). The shrinkage percentage is 5% [ ($five,000/100,000) x 100].

Causes of Inventory Shrinkage

The National Retail Security Survey outlines the following five factors as the leading causes of inventory shrinkage:

1. Shoplifting

Shoplifting occurs when a customer exits a store with more than what they paid for at the cashier. Shoplifting accounts for 38% of inventory shrinkage, and it surpassed employee theft as the leading crusade of shrinkage in the 2016 National Retail Security Survey. Fifty-fifty as stores increase security through the utilise of CCTV cameras, digital tags, and other ways, some customers nevertheless manage to steal inventory.

two. Employee theft

Although employees should exist at the forefront of preventing inventory shrinkage, some dishonest employees may steal from their employers. Employees may take some of the business organization stock to recoup for an amount they experience they are being underpaid, underappreciated, or undervalued. By being insiders of the company, they may quickly cover up the theft of inventory.

In most cases, the employer may not detect when one product disappears from a huge stock of over a thousand items. Instead, the employer/accountant volition assume that the production went missing due to clerical errors during packaging or when loading appurtenances onto a truck.

3. Administrative errors

Although most businesses accept moved from paperwork to digital methods of tape-keeping, administrative and paperwork errors are however among the leading causes of shrinkage. Authoritative errors may include pricing mistakes, accidental reorders, missing or additional zeros, or left-out decimal points. To reduce such errors, inventory should be physically counted and re-counted even when the business concern relies on automated systems.

four. Supplier fraud

In businesses with complex supply chains, the inventory may at ane betoken be handled by third parties who are not part of the company. The theft may occur during transit from the supplier's warehouse to the business premises or when loading and unloading the products. Deliveries should be counted every time they enter or leave the business premises and recorded accordingly.

5. Unknown causes

Sometimes, inventory may disappear off the shelves and cannot be matched to any of the other causes of inventory shrinkage. Unknown causes stand for about six percent of the total inventory shrinkage.

How to Prevent Inventory Shrinkage?

1. Implement a double-cheque organization

The initial action that a business organization should take to prevent inventory shrinkage is to implement a double-check system. It should have more than than one person assigned to important inventory management stages, such as signing invoices, recording stock, and accepting stock.

Getting a second person to verify the records helps prevent inaccuracy and omission of key details. A double-cheque system besides helps to place loopholes that may contribute to stock shrinkage and to implement measures to adjourn fraud.

ii. Vet potential employees thoroughly

Before hiring employees, a company should vet potential employees and do a groundwork check to weed out those with a history of stealing inventory. The company should contact the references and past employers to know the behavior and general conduct of a prospective employee.

If a prospective employee demonstrates a long history of improper conduct, the company should probably non rent them. Hired employees should undergo rigorous training on how to handle inventory accordingly and comport out stock-taking.

3. Automate inventory management

Automating the inventory management process can help foreclose errors and omissions caused by humans. A defended inventory management software program will assistance reduce transmission handling of stock and cut downward on inventory shrinkage.

The software will concord all parties involved in the inventory management process accountable. It will track the location of the inventory from the point of origin to the point of auction, count the number of keystrokes, and produce logs for all the users who logged into the organization.

4. Track inventory shrinkage

An organization should rail the inventory shrinkage percentage over time to judge whether in that location is an increment or a decrease in shrinkage. The inventory count should be compared to the previous inventory counts.

If the shrinkage percentage has decreased over time, information technology shows that the company'due south inventory management techniques have reduced stock shrinkage. However, if the inventory shrinkage per centum increases over time, then the visitor should review the measures they have implemented to identify and correct whatever potential problems.

Existent-World Information

According to the 2016 National Security Survey, businesses in the United states lost $45.2 billion through inventory shrinkage in 2015. The corporeality represented a significant increase from the $35.three billion recorded in 2008 during the National Retail Security Survey (2008).

According to the 2016 survey, shoplifting and employee theft were the largest causes of inventory loss. In 2008, employee theft represented 42.7%, while shoplifting represented 35.6% of the total inventory shrinkage.

Additional Resource

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)® certification program, designed to transform anyone into a earth-class fiscal analyst.

To keep learning and developing your knowledge of fiscal assay, we highly recommend the additional CFI resources below:

Tangible Avails
Fixed and Variable Costs
Projecting Income Statement Line Items
Projecting Balance Sheet Line Items