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What is the journal entry to record an adjustment to inventory after a physical inventory observation?

 When a company performs a physical inventory observation, they are comparing the physical counted quantities from the warehouse floor to what the quantity is per the inventory system.

If inventory per the physical count is more than what the system has recorded, that means that not as many goods were sold and cost of goods sold needs to be reduced. The company would increase inventory by debiting inventory (increases inventory) and crediting cost of goods sold (reduces expense).

If inventory per the physical count is less than what the system has recorded, then that means that more items were sold, and the company needs to increase cost of goods sold. The company would decrease inventory and increase cost of goods sold. Therefore, the debit would be to cost of goods sold and the credit would be to inventory.

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