Perpetual Inventory System 2 Example Exercise 6 Inventory Shrinkage Perpetual Inventory System Using the perpetual inventory system, the merchandise inventory account is continually updated for purchase and sales transactions. Businesses are required under both the periodic and the perpetual inventory methods to do a physical count of their inventory each year. This sometimes results in the physical inventory not being equal to the amount recorded due to shoplifting, employee theft or errors [CLICK]. Thus, the physical inventory on hand could be less than the balance in the Merchandise Inventory account. The difference is called inventory shrinkage or inventory shortage [CLICK]. Due to this loss, an adjusting entry must be recorded.

Example Exercise 6 6 Let’s look at an example of inventory shrinkage for Pulmonary Company. First, we must determine the amount of inventory shrinkage. The account balance of merchandise inventory per the accounting records is $382,800. The amount of inventory according to the physical count is $371,350. [CLICK] The difference of $11,550 must be recorded as a reduction to inventory.

2 Example Exercise 6 6 Next, we have to decide how to prepare the journal entry to record the inventory shrinkage. Since the physical inventory shows $11,550 less in inventory than the accounting records, we must reduce the Merchandise Inventory account to reflect this loss by crediting Merchandise Inventory. Since it’s a normal amount of loss, we debit Cost of Merchandise Sold. If it was a larger than normal amount of loss, we might set up a separate account called Inventory Shrinkage or Loss from Inventory Shrinkage.

Example Exercise 6 6  For Practice: PE 6A, PE 6B 6 Refer to Practice Exercises PE 6A and PE 6B to practice on inventory shrinkage. 6A, 6B  For Practice: PE 6A, PE 6B