Supplies and inventory shrinkage: adjusting the books to a physical count

The books say one thing; the shelves say another. At the end of a period, a business counts what it actually has and adjusts its accounts to match. Two of the most common count-based adjustments are supplies used and inventory shrinkage. They share one idea: the count tells you what is left, and the entry records what is gone. This page explains both, with worked examples and the mistakes our exercises check for.

Why a count leads to an adjusting entry

Some assets are used up a little at a time, so it is not practical to record every use. Nobody makes a journal entry each time someone takes a box of printer paper or a roll of labels. Other assets disappear without anyone recording it at all: goods are damaged, misplaced, miscounted or stolen. In both cases the account balance drifts away from reality during the period.

A physical count fixes this. At the end of the period, someone counts what is actually there and puts a cost on it. The difference between the account balance and the count is the amount that was used or lost, and that is the amount of the adjusting entry.

The rule that holds for both adjustments is short enough to memorize:

Adjustment = what the books say − what the count finds.

Supplies used

Supplies are small items a business uses in its own operations: paper, cleaning products, packaging, pens. They are not for resale. Many businesses record supply purchases in an asset account called Supplies. The asset is then reduced at the end of the period for what was used.

The amount used comes from a simple flow:

Supplies used = opening balance + purchases − supplies on hand

The entry moves that amount from the asset to an expense:

• Debit Supplies Expense: the cost of what was used this period.
• Credit Supplies: the asset goes down by the same amount.

After the entry, the Supplies account equals the counted amount on hand, which is what the balance sheet should show.

Worked example 1: supplies used in December

Harbor Bakery's Supplies account had a $1,051.34 balance at the start of December. During the month it bought $2,645.11 of supplies and recorded them in Supplies. A count at the end of December found $3,360.80 of supplies still on hand.

First, find the balance the books show before adjusting:

$1,051.34 + $2,645.11 = $3,696.45

Then subtract what is still on hand:

$3,696.45 − $3,360.80 = $335.65

The bakery used $335.65 of supplies in December. The Supplies account now shows $3,360.80, which matches the count. It can look odd that the expense is much smaller than the month's purchases, but that is common: most of December's purchases are still sitting on the shelf, ready for January.

Inventory shrinkage

Inventory, or merchandise, is goods a business holds to sell. A business with a perpetual inventory system updates its Inventory account at every purchase and every sale, so the account always shows what should be on hand. Even so, the count rarely matches exactly. The shortfall is called shrinkage. It covers anything that reduces stock without a recorded sale: theft, damage, spoilage, and errors in receiving or recording.

Shrinkage is normally charged to Cost of Goods Sold, because it is part of the cost of carrying goods to sell. The entry is:

• Debit Cost of Goods Sold: the cost of the missing goods.
• Credit Inventory: the asset goes down to the counted amount.

Inventory is always carried at cost, so shrinkage is measured at cost too, never at the price the goods would have sold for.

Worked example 2: shrinkage in dollars

Juniper Landscaping keeps a perpetual inventory record, which shows $50,057.74 of merchandise at year end. A physical count finds merchandise costing $46,749.03.

$50,057.74 − $46,749.03 = $3,308.71

After posting, Inventory shows $46,749.03, the amount actually on hand.

Worked example 3: shrinkage in units

Sometimes the count is given in units, not dollars. Pine Street Dental's perpetual record shows 339 notebook sets on hand, each costing $6.10. They sell for $12.00 each. The year-end count finds only 319.

Find the missing units, then value them at cost:

339 − 319 = 20 units
20 × $6.10 = $122.00

Debit Cost of Goods Sold and credit Inventory for $122.00. The $12.00 selling price is extra information. It tells you what the business might have earned, but the asset was never recorded at that price.

Worked example 4: both adjustments in one entry

At year end, Juniper Landscaping counts everything. The Supplies account shows $3,875.03 (opening balance plus purchases), and $2,042.29 is on hand. The perpetual inventory record shows $19,452.70, and the count finds $19,376.84.

Supplies used: $3,875.03 − $2,042.29 = $1,832.74
Shrinkage: $19,452.70 − $19,376.84 = $75.86

Both can go in one compound entry, as long as each cost lands in its own account:

Common mistakes and how to avoid them

These are the mistakes our exercises look for. Most come from mixing up what is left with what is gone.

Expensing the amount on hand

The count is what the business still owns. It stays an asset. In the Harbor Bakery example, expensing $3,360.80 would remove nearly all the supplies from the books while they are still on the shelf. Expense what was used: opening balance plus purchases minus on hand.

Expensing only the period's purchases

The supplies used in a month can come from what was left over last month as well as from new purchases. Expensing only the $2,645.11 bought in December ignores the opening balance and ignores what is still on hand. Use the full formula.

Reversing the debit and credit

Supplies Expense increases, so it is debited. The Supplies asset decreases, so it is credited. Swapping them would increase the asset and record a negative expense.

Recording the counted amount as shrinkage

The same trap applies to inventory. The count, $46,749.03 in the Juniper example, is what is still on the shelf. The adjustment is only the shortfall: record minus count.

Debiting Inventory for shrinkage

Missing goods mean less inventory, so Inventory is credited. The cost is recognized by debiting Cost of Goods Sold.

Valuing missing units at the selling price

Inventory is carried at cost. Twenty missing notebook sets at $12.00 would be $240.00, nearly double the correct $122.00. Multiply the missing units by the unit cost.

Charging shrinkage to Supplies Expense

In a combined entry it is tempting to put everything into one expense line. Supplies are used in running the business; merchandise is bought to sell. Missing merchandise is a cost of goods sold, so keep the two debits separate.

How these entries affect the financial statements

It helps to see where each number ends up. Both adjustments move an amount from the balance sheet to the income statement.

Before the supplies entry, Harbor Bakery's balance sheet would show $3,696.45 of supplies, which overstates what it owns by $335.65, and its income statement would show no supplies expense for December, which overstates profit by the same amount. After the entry, both statements are right. The adjustment does not create a cost; it moves a cost that already happened into the period where it belongs.

Shrinkage works the same way. Juniper Landscaping's Inventory would be overstated by $3,308.71 without the entry, and cost of goods sold would be understated. Because shrinkage raises cost of goods sold, it lowers gross profit, the difference between sales and the cost of the goods sold. That is useful information: a manager who sees gross profit fall can ask whether prices, costs or losses are the cause.

Neither adjustment involves Cash. The cash left the business when the supplies or goods were bought. The adjustment only decides which period carries the cost.

A quick routine for count-based adjustments

1. Find what the books say: the account balance, including any purchases during the period.
2. Find what the count says, in dollars at cost. Convert units to dollars at unit cost if needed.
3. Subtract: books minus count is the amount used or lost.
4. Debit the right cost account: Supplies Expense for supplies, Cost of Goods Sold for merchandise.
5. Credit the asset, then check that its new balance equals the count.