Losses: definition, control, accounting treatment and impact on costs

What are losses?

Shrinkage is a loss of inventory (raw materials, products in process or finished goods) that occurs during production, storage or sale.
They are classified into:

• Normal losses: unavoidable due to the nature of the process (example: evaporation, cuts, expected waste).
• Abnormal losses: exceed what is expected and are due to errors, failures, deterioration or poor management.

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How to control losses

1. Standardize processes (recipes, yields, quality controls).
2. Record inventory entries and exits in detail.
3. Define shrinkage KPIs (percentage of shrinkage over sales or production).
4. Use inventory or ERP systems for traceability.
5. Train staff in good management practices.
6. Establish acceptable limits for loss and liability for exceeding them.

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Accounting treatment

The accounting record depends on whether the loss is normal or abnormal.

1. Normal shrinkage
It is integrated into the cost of production or cost of sales.
Accounting entry example:

• Work in process inventory (cost of production) XXX
• Raw materials warehouse XXX

2. Abnormal shrinkage
It is recognized as an expense in the income statement.
Accounting entry example:

• Abnormal shrinkage loss XXX
• Raw materials warehouse XXX

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Impact on costs

• Increased unit cost: Normal shrinkage increases the cost of each finished product.
• Reduction in profit margin: since it is not planned, it directly affects profitability.
• Deviation from standards: Higher-than-expected losses reflect inefficiencies.
• Impact on strategic decisions: influences sales prices, input purchases, and process design.