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Merchandise Inventory Summary

To summarize, the merchandise inventory account is

• increased by
  • purchases,
  • freight-in, and
  • goods returned (at cost) and
• decreased by
  • purchase returns,
  • purchase discounts,
  • goods sold (at cost), and
  • shrinkage.

Inventory Shrinkage

At the end of the accounting period, we are required to complete a physical count of inventory on hand. We will compare the inventory recorded in our accounting records to the actual inventory on hand. Shrinkage is the difference between the inventory recorded in the accounting records and the actual inventory on hand. Shrinkage includes

• damaged items that were never counted,
• damaged goods that were received but never set out for sale,
• spoiled merchandise that was thrown out and not counted, and
• items lost due to theft.

What happened? We purchased items of inventory, recorded them in the accounting records, and believed that they were in inventory and available for sale, but they are either damaged or missing.

Merchandising businesses are required to record an adjusting entry to note inventory shrinkage. We are adjusting our accounts to report the actual number of items available for sale. When we prepare the adjusting entry, the merchandise inventory account is adjusted to equal the physical count. This adjustment decreases (credits) the merchandise inventory account and increases (debits) the cost of goods sold. We decrease the inventory account because we don’t have the inventory. We debit COGS because their cost was attributed to inventory that is no longer available to be sold.

While the adjusting entry is beyond the scope of material covered in this course, we should note that shrinkage is a very important issue for merchandisers: "According to the 2015 National Retail Security Survey…inventory shrink averaged 1.38% of retail sales in 2014, resulting in the loss of $44 billion." (Griffin, 2015)