What is shrinkage?

Definition

Shrinkage is stock that left the shelf without a sale: stolen, ruined, or never there because the count was wrong. On the books, this is a reduction of inventory, with a matching charge on the profit and loss statement.

The units are gone, or they never matched the recorded quantity. The loss is the cost of those missing goods.

Where it shows up

Balance Sheet: Related to the inventory line when units are missing.

P&L: Related to cost of goods sold when the loss is recorded.

See also: Physical Inventory Count · Cost Of Goods Sold · Inventory

When you look at your Balance Sheet, shrinkage shows up as a smaller inventory line after you record the missing units. Until you post it, the books still claim stock that is not there.

A large amount relative to sales can mean theft, poor receiving, or a sloppy count. A small amount is common; zero is unusual for a shop that handles a lot of small items.

The profit and loss statement picks up the cost when the loss is recorded. It often sits in cost of goods sold, or as its own line so a reader can see it.

This entry is typically non-cash at the moment you record it. Cash already left when you bought the goods; the entry only takes the missing units off the books.

A physical inventory count is how many shops find the gap. A cycle count can find it in a single aisle without waiting for year end.

How it works

You start from the recorded inventory balance. Shrinkage is the gap between that balance and what is actually on the shelf.

Theft, breakage, spoilage, and counting error all land in that gap. The books do not always know which one happened; they know the units are missing.

A receiving error can create the same gap. If you recorded 100 units and only 90 arrived, the extra 10 on the books are shrinkage until you correct them.

You record it by debiting cost of goods sold, or a shrinkage expense, and crediting inventory. After that entry, the stock line matches the shelf.

Some books run small, recurring amounts through cost of goods sold. A large, unusual loss is often shown on its own so a reader can see it.

Locked cabinets, cameras, two people receiving, and regular counts try to keep the gap small. The entry is what records the gap once it exists.

Shrinkage is not a write-down of goods that are still there. A write-down reduces value; this entry reduces units.

It is also not an inventory reserve. The reserve is an estimate against stock you still hold; this entry takes missing units off the books.

Keep the amount tied to the count or the known incident. A round plug with no count behind it is hard to defend.

Example

A neighborhood pharmacy counts the stockroom at month end. The books say $6,000 of over-the-counter items; the count finds $5,600.

The $400 gap is missing units, not a markdown. The pharmacy records the loss.

Debit: Cost of goods sold $400

Credit: Inventory $400

Inventory on the Balance Sheet falls by $400. The profit and loss statement takes $400 of cost in the same period.

Assets are lower by $400, and equity is lower through the loss. Cash does not move now, because those items were paid for when they were purchased.

The count is what revealed the gap. The entry is what made the books match the shelf.

Common mix-ups

Shrinkage is not a write-down. A write-down is units that are still there but worth less than cost; shrinkage is units that are gone.

Shrinkage is not the count itself. The count finds the gap; the entry records it.

Shrinkage is not the same as an inventory reserve. The reserve estimates value you will not recover on goods you still hold.

Related terms

• Physical Inventory Count: A full hands-on count of stock used to correct the recorded balance.
• Cycle Count: Counting a rotating subset of inventory on an ongoing schedule instead of all at once.
• Inventory: Goods held for sale or used to produce goods for sale.
• Cost Of Goods Sold: The direct cost of the products sold during the period.
• Inventory Write-Down: Reducing the carrying value of inventory that is damaged, slow, or worth less than cost.
• Internal Controls: The procedures that keep the books accurate and assets protected.
• Inventory Reserve: A contra-asset account estimating inventory value that will not be recovered.
• Gross Margin: Gross profit expressed as a percentage of revenue.