What Is an Inventory Adjustment? (With Examples and Tips)
Updated March 3, 2023
Sometimes, a company may notice differences in stock numbers when making annual inventory counts. The company can then investigate the source of these differences and adjust inventory reports to maintain accurate business records. Learning more about this process of inventory adjustment and why it's important can help you develop the skills to manage evolving inventory data.
In this article, we define inventory adjustments and why they're important, describe how to calculate inventory adjustments and offer examples and tips to help you adjust a company's inventory.
What is an inventory adjustment?
An inventory adjustment is an increase or decrease in a company's inventory to explain theft, broken products, loss or other errors. Sometimes, companies may see these changes during annual inventory counts or periodic accounting entries. Inventory adjustments also may come from other areas besides sales, such as:
Waste, like expired products
Damage, like broken products
Internal use, like products the company used
Inventory adjustment reports often detail which product is missing, how much it costs and how much a company lost. An accounting team may use these adjustments to calculate the beginning inventory versus ending inventory when finalizing records for the current year. This can help a company understand how effective its inventory storage and tracking systems are, which can help locate potential areas for improvement.
Why are inventory adjustments important?
Inventory adjustments are important because they can help a company reflect changes that may not be in official records and also maintain responsible accounting practices. These adjustments maintain accurate pricing on products, such as by making sure the cost of an item doesn't increase or decrease because of miscalculations of the item's stock. An accurate representation of inventory stock can help a company gain an accurate view of its overall financial well-being.
Calculating inventory adjustments can also help calculate gross profits. The cost of goods sold (COGS) includes the expenses and effort that went into selling inventory during a selected amount of time. You could then record this on an income statement and use it to calculate a company's gross profits. Without accurate inventory data, you may determine an inaccurate or misleading gross profit number.
Types of inventory adjustments
There are three main types of inventory adjustments that a company may make:
Decreasing quantity: This is when a company adjusts the total value of an item when there's a lower amount in stock than it originally recorded.
Increasing quantity: This is when a company adjusts the total value of an item when there is a higher quantity in stock than it originally recorded.
Reevaluation: This is when the amount of stock doesn't change, but management manually changes an item's cost and total value.
Related: Guide to Physical Inventories
How to make an inventory adjustment
Here are a few simple steps you can follow to make an inventory adjustment:
1. Gather information
Determine the amount of the company's beginning inventory for the period you're calculating. You may collaborate with the accounting department to get the information for these calculations. Find the monetary amount of all purchases for that period and add it to your total inventory. You can also determine the monetary amount of the company's inventory for the end of this time period.
2. Calculate the cost of goods sold
The basic formula for calculating the cost of goods sold (COGS) is:
Beginning inventory + purchases - ending inventory = COGS
You can add the numbers you gathered into this formula by adding the beginning inventory calculation to the total purchases and subtracting the ending inventory. The resulting number then describes the costs associated with acquiring or manufacturing a company's products.
3. Evaluate inventory
The COGS number can tell you if the company's inventory is overstated, understated or correctly stated in its records. If a company begins with a certain amount of product in inventory, sells all that inventory and ends up with a lower or higher COGS than expected, it can mean that there was a slight miscalculation while tracking that inventory. From there, you can adjust inventory numbers or product prices to reflect the new information.
Inventory adjustment examples
Here are a few examples of the different inventory adjustments:
A cosmetic company has an initial inventory amount of $5,000 at the beginning of the year. Its total amount of products sold and total ending inventory for the year also equal $5,000. This means that the company has an accurate record of gross and net profits, income statements and a general idea of the company's health. This calculation would look like this:
$5,000 of beginning inventory + $5,000 of total purchases - $5,000 of ending inventory = $5,000 COGS
A grocery store chain has $40,000 of beginning inventory. Its total purchase amount equals $40,000 and its ending inventory amount equals $35,000. This shows that there is an understatement of $5,000 in ending inventory and management may increase the price of goods by $5,000 to make up for lost inventory. The calculation for this would be:
$40,000 of beginning inventory + $40,000 total purchase amount - $35,000 of ending inventory = $45,000 COGS
A shoe retailer has an initial inventory amount of $8,000, with a total purchase amount of $8,000. Its ending inventory is $8,500, which shows there is an overstatement of $500 in the final inventory amount. This means that the company may reduce the cost of goods by $500 to make up for extra inventory in its financial accounts. The calculation looks like this:
$8,000 of beginning inventory + $8,000 of total purchases - $8,500 of total ending inventory = $7,500 COGS
Tips for making inventory adjustments
Here are a few tips to help you make accurate inventory adjustments:
Make occasional counts throughout the period you're calculating. This can help you catch inventory inconsistencies as they happen and reduce the amount of work it takes to calculate your adjustments at the end of the allotted time. It can also help prevent overstated and understated inventory.
Use specific software applications to help you simplify the process. Many software applications are available online or through other organizations to help you with organizing, balancing, entering adjustments and journal entries and preparing financial statements. This can reduce the time to manage your inventory and also provide an easy way to access all your information.
Communicate adjustments and updates to other parts of the company. Communication can help you manage the company's inventory and prevent confusion over differences. Depending on the size of the company and the situation, you can use software that automatically notifies other departments of updates.
Recognize and learn from your mistakes to avoid future issues. It's important to recognize the source of any variations to prevent them from occurring in the future. Preventative measures might include changing how you document inventory adjustments, improving communication habits across the company or hosting training workshops for employees.
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