Shrinkage and wastage

Shrinkage - the gap between book inventory and physical inventory caused by theft, breakage, spoilage, or administrative error - is a routine and often material cost of doing business in retail, particularly in supermarkets and high-footfall stores. Under IAS 2, these losses are not a valuation adjustment to NRV; they represent inventory that no longer exists or was never as recorded, so they must be expensed as incurred through cost of sales rather than capitalised, deferred, or netted against unrelated provisions. Conflating shrinkage with NRV write-downs, or delaying recognition until an annual count, misstates interim cost of sales and can obscure a growing loss-prevention problem from management and those charged with governance. Proper identification and prompt expensing of shrinkage also supports internal control monitoring and loss-prevention decision-making.

How frequently are cycle counts and full stocktakes performed, and is shrinkage tracked by store/category to identify control weaknesses? Has each material count variance been investigated to separate genuine shrinkage from cut-off timing differences before being written off? Is shrinkage measured at cost (not selling price), consistent with the cost basis the inventory was carried at before the loss?

1. Maintain perpetual (book) inventory records and perform periodic physical stocktakes (cycle counts and/or full counts) to identify variances between book and physical quantities.
2. Investigate variances to distinguish shrinkage (theft, breakage, spoilage, administrative/counting error) from timing differences (e.g., goods in transit, unrecorded receipts).
3. Recognise confirmed shrinkage as an expense in cost of sales (or a separate shrinkage/inventory loss line) in the period the count is performed and the loss is identified - do not wait for year-end or defer over future periods.
4. Where shrinkage is estimated between physical counts (e.g., monthly accrual based on historical shrinkage rates), true-up the estimate to actual results at the next physical count.
5. Do not net shrinkage against inventory write-downs recognised under the NRV test; keep the two matters and their disclosures distinct since they arise from different causes (quantity loss vs. valuation).
6. Escalate significant or unusual shrinkage patterns for investigation as a potential internal control deficiency or fraud indicator, which may also carry disclosure or governance implications.

Shrinkage is measured as the cost (not selling price) of the missing or damaged inventory, consistent with the cost basis at which the inventory was carried before the loss (e.g., using the same retail method cost-to-retail ratio applied to the missing retail-value quantity). Between full physical counts, many retailers accrue an estimated shrinkage expense based on historical shrinkage rates as a percentage of sales or cost of goods sold; this estimate is a provision-like accrual that must be reconciled and adjusted to actual results once the next physical count is completed, with any difference recognised in the period the count occurs. Shrinkage should not be measured net of insurance recoveries unless recovery is virtually certain; any insurance or employee restitution recovery is recognised separately as income/receivable when realisation is reasonably assured, not netted against the original loss.

Accounting policy describing how shrinkage is identified, estimated between counts, and recognised; amount of shrinkage/inventory loss expense recognised in cost of sales for the period (if material, disclosed separately or explained in MD&A/notes); basis and key assumptions used for interim shrinkage accruals (e.g., historical shrinkage rate applied); any receivable recognised for insurance claims or employee restitution related to shrinkage, presented separately from the loss itself; description of significant internal control weaknesses or unusual shrinkage events if relevant to understanding the financial statements; distinction made between shrinkage losses and NRV write-downs where both are disclosed

• Recording shrinkage as a reduction of revenue instead of an increase in cost of sales/inventory loss expense
• netting shrinkage losses against unrelated provisions or against NRV write-downs, obscuring the true nature and amount of each
• failing to accrue an estimate for shrinkage between physical counts, causing large one-off adjustments (and distorted interim margins) only at year-end
• measuring the loss at retail/selling price rather than cost, overstating the expense
• recognising anticipated insurance recovery net against the loss before recovery is virtually certain
• treating recurring, systemic shrinkage purely as an operational issue without assessing whether it indicates a material internal control deficiency requiring governance attention or disclosure.