Before You Start

This guide assumes you have active inventory tracking set up in your accounting software. Familiarity with your Chart of Accounts, especially COGS and expense accounts, is beneficial.

Overview

20 min
Setup Time
Intermediate
Difficulty
As needed
Maintenance

What You’ll Learn

  • How to identify common reasons for inventory discrepancies
  • Using your accounting software’s dedicated adjustment tools
  • Selecting the correct expense accounts for shrinkage and damaged goods
  • Maintaining a clear audit trail for all inventory adjustments

1. Understanding Inventory Discrepancies

Inventory discrepancies can arise from various sources, impacting your financial statements and stock levels:

Common Causes

  • Shrinkage: Theft, loss, spoilage, or administrative errors.
  • Damaged Goods: Items rendered unsellable due to transit, storage, or handling.
  • Miscounts: Errors during physical counts, receiving, or picking.

Key Accounts Involved

  • Inventory Asset (Balance Sheet)
  • Cost of Goods Sold (P&L, often for standard sales)
  • Inventory Shrinkage Expense (P&L, specific to lost/stolen/spoiled)
  • Damaged Goods Expense (P&L, specific to unsellable items)

2. Choosing Your Adjustment Method

You have two primary ways to correct inventory, depending on your system and the complexity of the issue.

Method A: Dedicated Inventory Adjustment Tools

Most modern accounting software (QuickBooks, Xero) offers specific functions for inventory adjustments.

Pros:
  • Automatically adjusts inventory quantity and value.
  • Maintains an audit trail per item.
  • Reduces manual journal entry errors.
Cons:
  • May require specific item setup.
  • Less flexible for complex debits/credits.
  • Can be limited in reporting detail for why an adjustment occurred.

Method B: Manual Journal Entries

This method provides full control but requires a deeper understanding of debits and credits.

Expert Tip: For businesses using perpetual inventory systems, always try to use your accounting software’s dedicated inventory adjustment feature first. It ensures proper inventory valuation and COGS calculations per item. Manual journal entries are best for non-inventory items or very specific, complex scenarios not covered by the adjustment tool.

3. Step-by-Step: Making an Inventory Adjustment

Here’s a general workflow for correcting inventory using your software’s dedicated tools.

Here is a sample code block to show how an inventory adjustment might be represented in an API call for a system integration.

{
  "adjustment_id": "ADJ-2025-001",
  "date": "2025-10-20",
  "inventory_item_id": "SKU007",
  "quantity_change": -5,
  "reason": "Shrinkage",
  "cost_per_unit": 12.50,
  "account_impacted": "Inventory Shrinkage Expense"
}

4. Recording Shrinkage and Damaged Goods

  1. 1

    Identify Discrepancy

    Conduct a physical count or review reports to identify items that are missing, damaged, or miscounted.

  2. 2

    Initiate Adjustment

    Go to your software’s “Inventory Adjustment” or “Adjust Quantity/Value On Hand” section.

  3. 3

    Select Items and Quantity

    Choose the specific inventory items and enter the quantity change (e.g., -5 for 5 missing items).

  4. 4

    Assign Expense Account

    Crucially, assign the impact of the adjustment to the correct expense account (e.g., ‘Inventory Shrinkage Expense’ or ‘Damaged Goods Expense’).

  5. 5

    Add Memo and Save

    Include a clear memo explaining the reason for the adjustment. Review and save.

Common Error: Incorrect Expense Account

Do NOT typically post inventory adjustments directly to “Cost of Goods Sold” unless specifically instructed by an accountant for a very particular scenario (e.g., for periodic inventory systems or specific write-offs). Always use dedicated ‘Shrinkage’ or ‘Damaged Goods’ expense accounts for clarity and proper reporting.

5. Audit and Reconciliation

Post-Adjustment Checklist

  • Review the General Ledger for the Inventory Asset account.
  • Verify that the corresponding expense account (Shrinkage/Damaged) reflects the adjustment.
  • Compare your physical inventory count to your system’s new quantity on hand.
  • Check your Profit & Loss statement to see the impact of the expense.

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