What is inventory shrinkage?

Inventory shrinkage is the excess of inventory listed in the accounting records, but which no longer exists in the actual inventory. Its disappearance may be due to theft, damage, miscounting, incorrect units of measure, or evaporation.

It is also possible that shrinkage can be caused by supplier fraud, where a supplier bills a company for a certain number of goods shipped, but does not actually ship all of the goods. The recipient therefore records the invoice for the full cost of the goods, but records fewer units in stock, resulting in shrinkage.

To measure the amount of inventory shrinkage, conduct a physical count of the inventory and calculate its cost, and then subtract this cost from the cost listed in the accounting records. Divide the difference by the amount in the accounting records to arrive at the inventory shrinkage percentage.

For example, ABC International has $1,000,000 of inventory listed in its accounting records. It conducts a physical inventory count, and calculates that the actual amount on hand is $950,000. The amount of inventory shrinkage is therefore $50,000 ($1,000,000 book cost - $950,000 actual cost). The inventory shrinkage percentage is 5% ($50,000 shrinkage / $1,000,000 book cost).

There are many techniques available for preventing inventory shrinkage, including:

• Fencing off the warehouse
• Preventing anyone except warehouse staff from entering the warehouse
• Instituting bin-level tracking of inventory items
• Assigning personal responsibility for inventory accuracy
• Improving the accuracy of bill of materials records
• Installing an ongoing cycle counting process

Related Topics

How do I report an inventory write down?
How do I write down inventory?
Inventory audit procedures
Inventory internal controls
Types of inventory errors