Definition: Shrinkage is the loss or expense recorded when inventory is either stolen or destroyed. In any business where inventory is a significant source of sales, shrinkage, often shortened to shrink, is monitored closely.
What Does Inventory Shrinkage Mean?
Retailers, in particular, monitor this internally and externally. Internal shrinkage occurs when the employees or other people inside the company steal inventory. External shrinkage, on the other hand, refers to customers or people outside the organization stealing the inventory. Believe it or not, retailers have to watch both of these forms of theft equally. In some cases internal theft is more prevalent than external theft.
Internal controls are typically put in place to help prevent employees and customers from stealing company inventory. The most common control that we see when we walk into department stores is magnetic detectors. A small magnetic device attached to each piece of inventory activates these detectors, so if someone tries to leave the store with a piece of inventory that hasn’t been scanned the alarm will ring.
These types of anti-shoplifting devices are primarily focused on external customers. Employees have access to the scanners that deactivate the magnetic devices. A common internal control designed to help prevent employee theft is personal searches. For example, the on duty manager might be in charge of searching purses, bags, and backpacks of employees before they are allowed to leave the store.
The shrinkage loss or expense is computed by comparing the recorded inventory in the accounting system with the actual amount of physical inventory counted. This is why it’s important to perform regular physical inventory counts. If the accounting system has $100,000 of recorded inventory and the manager only counts $80,000 of inventory in the store, there is a $20,000 shrinkage loss.
This loss is recorded by debiting the shrinkage or cost of goods sold account for $20,000 and crediting the merchandise inventory account for the same amount.