Inventory shrinkage is one of the most in SMEs.Unless tracked and adjusted correctly, it leads to misstated inventory, inflated profits, GST reversals, and audit qualifications.
This guide explains in a practical, audit-ready manner.
Inventory shrinkage is the difference between:
vs
Shrinkage arises due to:
- Theft (internal or external)
- Damage or breakage
- Expiry or obsolescence
- Pilferage
- Incorrect recording
- Production wastage
- Measurement errors
If not adjusted:
- Inventory value is overstated
- Profit is overstated
- GST ITC is wrongly claimed
- Cost of goods sold (COGS) is understated
- Auditors raise red flags
To explain:
- What inventory shrinkage is
- How to identify and measure it
- Accounting treatment for shrinkage and adjustments
- GST implications
- Internal controls to reduce shrinkage
Inventory shrinkage is that cannot be sold due to:
- Physical loss
- Deterioration
- Damage
- Theft
- Incorrect stock recording
Shrinkage is not a “future loss”—it is a once identified.
Physical stock verification should be done:
- Monthly (high-value inventory)
- Quarterly (medium-risk inventory)
- Annually (minimum requirement)
Compare:
- Physical quantity
- Book quantity
- Identify variances item-wise
Differences must be classified as:
Measurement / Posting Error
Correct classification determines accounting and GST treatment.
Inventory write-offs require:
- Explanation from warehouse/operations
- Approval from management
- Supporting evidence (photos, reports)
Unauthorised write-offs are audit red flags.
Inventory must be written off.
Inventory Shrinkage Expense A/c Dr
To Inventory / Stock A/c
This increases COGS or operating expense.
Write off fully or partially.
Obsolete Inventory Expense A/c Dr
To Inventory A/c
If scrap value exists → record separately.
Correction entry, not expense.
Inventory A/c Dr / Cr
To Adjustment A/c
- absorbed in product cost
- expensed separately
Abnormal Wastage Expense A/c Dr
To Inventory A/c
GST ITC must be reversed when goods are:
- Lost
- Stolen
- Destroyed
- Written off
- Disposed of by way of gift or free samples
Inventory Shrinkage Expense A/c Dr
To Input GST A/c
- Loss due to normal handling loss
- Loss due to process wastage
- Loss during manufacturing within norms
- Material shrinkage must be disclosed
- Impact on COGS should be analysed
- Repeated shrinkage requires internal control review
Maintain an .
This is critical for audit and GST defence.
- Poor warehouse security
- Lack of bin-wise tracking
- Manual stock registers
- No periodic verification
- Untrained staff
- Inadequate documentation
- High staff turnover
- No accountability framework
- Segregation of duties
- CCTV & access control
- Barcode / SKU tracking
- FIFO inventory method
- Restricted store access
- Approval-based issue of goods
- Surprise stock counts
- Reconciliation of GRN vs invoice
- Periodic ageing analysis
- Shrinkage trend reports
- Ignoring stock differences
- Adjusting stock without documentation
- Not reversing GST ITC
- Writing off inventory to “miscellaneous”
- No approval for write-offs
- Not analysing repeated shrinkage
- Not distinguishing normal vs abnormal loss
These lead to audit qualifications and GST disputes.
Retail chain had recurring stock shortages but no write-off entries.
• Introduced quarterly stock verification• Created inventory adjustment register• Passed authorised shrinkage entries• Reversed ITC where required• Strengthened warehouse controls
• Accurate inventory valuation• Clean audit report• GST exposure eliminated
• Stock Verification Format• Inventory Adjustment Register• Shrinkage Analysis Sheet• GST ITC Reversal Working• Warehouse SOP• Inventory Control Checklist