A Simple Guide to How Minnesota Businesses Can Account for Lost Inventory

August 29, 2023 | Carl Corneliuson
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    Inventory shrinkage is a reality small business owners must face when they have products to sell that wind up lost, stolen, damaged or lose their value for some other reason. Grocery chains deal with spoiled groceries. Retailers face theft. Auto dealers cringe at thunderstorms with hail in the forecast. The loss scenarios are nearly endless.

    Lost or damaged inventory can be addressed first by filling out a damage report documenting the loss, and then inventory write-offs; an accounting choice signifying the items in question no longer have any value; or by utilizing a cost of goods sold (COGS) formula. Companies can do write-offs either directly or through an allowance method, which is a reserve set aside ahead of time by the business for anticipated bad debts.

    Damage Inventory Accounting Basics

    Having accurate records that track inventory losses is vital to company success, and it’s sometimes required to meet specific regulatory guidelines within an industry of work. Regardless of industry, here’s how inventory loss accounting should be handled at a high level:

    • Provide documentation. Whether you conduct regular inventories of goods or find discrepancies organically, you must identify lost products and, if possible, note the reason behind your lost or damaged inventory in order to account for losses accurately.
    • Count losses as expenses. In most instances, when putting together reporting for your organization’s income statement losses can be counted as expenses. Counting losses at fair market value is standard, so if someone steals an item from an electronics shop you own that you would charge $29.99 for, you can mark that amount when you go to report it.
    • (Sometimes) disclose losses in your financial statement. If you have a high amount of losses, you will need to disclose them in financial statements, making that information available to investors and other stakeholders within your company. A small amount of inventory loss does not require a separate disclosure on your income statement. An inventory write-off account should be set up for organizations that go through large inventory losses to simplify the write-off process.

    Most small businesses choose to do inventory write-offs at the end of a tax year, but if you run a company that has a large inventory with many losses to cover, you may want to address lost or damaged inventory accounting on a quarterly or monthly basis.

    How Accounting Impacts Inventory Losses

    Properly documenting inventory losses is significant for achieving financial accuracy, but it’s also handy information to have for business planning and analyzing operational efficiency. For example, when pricing goods, you should have a formula for COGS to ensure profitability of items. Also, when you have a small amount of losses, you can build that figure into your COGS instead of disclosing it in your financial statement.

    With the data you compile from reporting for your income statement or COGS, you can plug damage, spoilage, theft, and other loss factors into your pricing strategy as part of your organization’s ongoing budgeting and forecasting. Think of damage or loss inventory accounting as a way of optimizing your business financials, impacting how you adjust and finetune product pricing.

    Whether you have a write-off account or you put your losses into your COGS formula, inventory loss and damage accounting must be completed in a timely manner and cannot be spread over multiple reporting periods. Correct inventory loss accounting is also necessary to achieve regulatory compliance and accurate tax records. Consistency is key while adhering to tax laws to avoid costly mistakes and audits.

    Trust the Pros with Your Inventory Loss Accounting Needs

    Corneliuson & Associates, a small business accounting firm based near Minneapolis, Minnesota, offers deep expertise and customizable services to meet the needs of companies across The Land of 10,000 Lakes and western Wisconsin. Book a no-cost, no-obligation consultation today to discover how we can help grow your business with proven lost inventory accounting services.