Inventory shrinkage

Inventory shrinkage is the excess amount of inventory listed in the accounting records, but which no longer exists in the actual inventory. Excessive shrinkage levels can indicate problems with inventory theft, damage, miscounting, incorrect units of measure, evaporation, or similar issues. It is also possible that shrinkage can be caused by supplier fraud, where a supplier bills a company for a certain quantity 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; the difference is 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 and locking 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

  • Tightly controlling the results of the physical count process, and how adjustments are incorporated into the inventory records

  • Counting all items when they arrive at the receiving dock

  • Counting all finished goods when they are shipped from the company

Related Courses

Accounting for Inventory 
How to Audit Inventory