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What is the adjusting entry for a physical inventory adjustment?

A company will typically perform a physical inventory count on the last day of the fiscal year. The entire warehouse will be counted, and the company will aggregate the number of units by SKU to calculate total inventory on-hand. This will be captured in a document or file called the ‘inventory count sheet’. This is maintained by the company but the auditors will also review a copy.

This balance is compared to the inventory balance in the perpetual inventory listing (or the trial balance). Depending on the dollar amount of the difference, the company may need to book an adjustment to increase or decrease inventory. If there are differences, these differences are typically investigated at the SKU level by performing a recount in the warehouse. Ultimately, the company and the auditors will have to determine the most accurate count by SKU and that becomes the source of truth.

If the company needs to make an adjusting entry to increase inventory, the debit would be to inventory and the credit would be to cost of goods sold. For example, if the company needs to increase inventory by $25,000 based on the physical inventory count, the company would debit inventory for $25,000 and credit cost of goods sold for $25,000:

If the company needs to record an adjustment to decrease inventory, the debit would be to cost of goods sold and the credit would be to inventory:

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