A gift shop ended the year with a balance of $20,000 in the Merchandise Inventory account. A physical count of the inventory revealed that only $19,500 of inventory existed at year end. What journal entry is needed to adjust the Merchandise Inventory account?

Debit Cost of Goods Sold and credit Merchandise Inventory for $500.

Explanation:

When there is comparism between merchandise inventory and physical count, the difference noticed is accounted to shrinkage. It could be due to damage, clerical error, or goods being lost or stolen.

This affects the profitability of the business especially when shrinkage is large. Retailers tend to increase price of goods to make up for shrinkage losses.

The entry to record shrinkage is the debit cost of goods sold and credit merchandise inventory.

The journal entry made to record inventory shrinkage applies to many situations, e.g. theft, damage, miscounting, etc. Inventory shrinkage should not be recorded as cost of goods sold unless the loss has been identified and it results from natural occurring causes, e.g. evaporation of liquids. In this case, the most probable cause is theft since it is a gift store. So the journal entry should be:

Dr Inventory shrinkage expense 500

    Cr Merchandise inventory 500

Explanation:

Inventory shrinkage results from a difference between what should the inventory and what it really is. In this case the shrinkage = $20,000 - $19,500 = $500.

This account has a debit balance because it is considered an expense, and it should be used whenever the cause of the shrinkage was not a natural occurring event.

This account is different from an inventory write down used for rotten or expired products since you know the amount of rotten or expired products and why that happened, they are not missing.

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