Financial Accounting: An Integrated Statements Approach, 2nd Edition

230 Chapter 5 Accounting for Merchandise Operations

MERCHANDISE SHRINKAGE

Under the perpetual inventory system, a separate merchandise inventory account is

maintained in the ledger. During the accounting period, this account shows the amount

of merchandise for sale at any time. However, merchandising businesses may experi-

ence some loss of inventory due to shoplifting, employee theft, or errors in recording

or counting inventory. As a result, the physical inventorytaken at the end of the ac-

counting period may differ from the amount of inventory shown in the inventory

records. Normally, the amount of merchandise for sale, as indicated by the balance

of the merchandise inventory account, is larger than the total amount of merchan-

dise counted during the physical inventory. For this reason, the difference is often

calledinventory shrinkageorinventory shortage. One recent study estimated that in-

ventory shrinkage exceeds 1.7% of annual sales or $32 billion annually in the United

States.^7

To illustrate, Online Solutions’ inventory records, called the book inventory, indi-

cate that $63,950 of merchandise should be available for sale on December 31, 2010.

The physical inventory taken on December 31, 2010, however, indicates that only

$62,150 of merchandise is actually available for sale. The inventory shrinkage for the

year ending December 31, 2010, is $1,800, as shown below.

December 31, 2010, unadjusted book inventory $63,950

December 31, 2010, physical inventory 62,150

Inventory shrinkage $ 1,800

The adjusting entry to record the shrinkage is as follows:

7 Richard C. Holling, National Retail Security Survey, 2003.

Dec. 31 Cost of Merchandise Sold 1,800

Merchandise Inventory 1,800

After this entry has been recorded, the adjusted Merchandise Inventory (book in-

ventory) in the accounting records agrees with the actual physical inventory at the end

of the period. Since no system of procedures and safeguards can totally eliminate it,

inventory shrinkage is often considered a normal cost of operations. If the amount of

the shrinkage is abnormally large, it may be disclosed separately on the income state-

ment. In such cases, the shrinkage may be recorded in a separate account, such as Loss

from Merchandise Inventory Shrinkage.

SCF BS IS

—ATSET Ec

Describe the accounting

for merchandise shrinkage.

7