In plain English
Measure it as the book value minus the counted value. Sort by category.
Controls at receiving and the sales floor reduce it.
Why it matters
Shrinkage is profit that vanished without a sale. If you never count, the loss stays hidden in an inventory balance that is too high, and your margins look healthier than they are. When a count finally happens, a large adjustment can wipe out what you thought was a good year.
Tracking it by category also points to where the problem is, such as receiving errors, breakage or theft.
Worked example
Book $62,000 less count $59,800 is $2,200, or about 3.5%.
How to handle it
- Count inventory on a schedule, either all at once or in rotating sections.
- Compare each count with the book quantity or value and list the differences by item or category.
- Investigate large differences before posting, since some turn out to be receiving or data entry errors.
- Post the remaining difference to a shrinkage or inventory adjustment expense account with the count sheets attached.
Common mistakes
- Folding shrinkage into cost of goods sold with no separate line, which hides how large it is.
- Writing off every count difference without checking for unrecorded receipts or sales, which turns paperwork errors into losses.
- Counting only once a year, so a problem with one supplier or shift goes unnoticed for months.
Not the same as: Write-off
Shrinkage is a specific inventory loss discovered by counting. A write-off is a broader term for removing any value from the books, such as an uncollectible invoice or obsolete stock. See Write-off.
Go deeper
- Inventory Counts and Shrinkage: Keeping Stock Honest: How to run a physical inventory count, reconcile it to your books, record shrinkage, and reduce losses from theft, damage and errors.
- Year-End Inventory Count and Valuation Records: How to plan a physical inventory count, reconcile it to the books, record shrinkage and keep the valuation support your preparer needs.
Related terms
- Suspense account: A temporary account for transactions you cannot yet classify.
- Trial balance: A list of all account balances at a date, used to check that debits equal credits.
- Shareholder loan: Money an owner lends to the business or the business lends to an owner, tracked as a loan.
Common questions
What is a shrinkage?
Inventory lost to theft, damage, error or spoilage, found by comparing counts to the books.
Can you give an example of shrinkage?
Book $62,000 less count $59,800 is $2,200, or about 3.5%.
How can I tell theft from counting errors?
Recount the items with the largest differences and check recent receiving and sales records for them. Errors often reverse on a recount, while theft tends to show the same items missing repeatedly.
Should spoiled or damaged goods count as shrinkage?
Many businesses include them, but tracking damage and spoilage separately from unexplained loss gives a clearer picture of what to fix.
General information, not tax, legal or accounting advice. Confirm rules with the IRS, the NJ Division of Taxation or a licensed professional.