What is Shrinkage?

Shrinkage is the difference between the book and actual amount of inventory. Its disappearance may be due to theft, damage, miscounting, administrative errors, or evaporation. In the retail industry, the amount of inventory shrinkage represents a major reduction in profitability, so a number of methods are used to combat it, including security cameras, merchandise tagging, and security guards.

How to Measure Shrinkage

A good detective measure is to compare the inventory shrinkage levels for each department when a business has multiple locations, in order to spot unusually high shrinkage levels in some locations that may be caused by fraud or improper procedures. By using a number of locations as the baseline in this manner, it is easier to spot localized instances of excessive shrinkage. This information can also be compared to employee absences (such as vacation), to see if shrinkage levels decline when certain employees are absent.

Accounting for Shrinkage

The cost of the inventory lost to shrinkage is typically charged directly to the cost of goods sold. This means that any inventory losses are written off in the same reporting period in which they were initially discovered. Thus, no shrinkage losses can be carried forward for recognition in a future period.