 In this presentation, we will talk about inventory shrinkage, the idea of the inventory going down for some reason other than the sale of inventory, so the inventory is decreasing for some reason, whether that be through spoilage or loss or theft, and the way that we're going to figure that out is to do a physical count. We will count the inventory and double check that inventory to our records, make adjustments as needed. It's important to note that this physical count process will be necessary whether we do a periodic system of inventory or a perpetual system. We'll demonstrate it with the perpetual system because that's going to be a system where we may get the idea that because we're recording the inventory as we go, that we don't need to go back and do that physical count because we're doing it as we go unlike a periodic system where the count is required in order for us to record the reduction in the inventory and related cost of goods sold. In order to consider this, we're going to say that we have a physical count and we're going to say at the end of the time period, the physical count is $23,000. We're talking $23,000 worth of inventory and that's a bit of a step in that we obviously would be counting units of inventory and then converting them to dollars in some way. Once we're going to get into that conversion at this point, we're just going to get the idea or the concepts that we want to adjust our books to the physical count. Once we see the physical count, we'll say, okay, if we look at our inventory on the books, it's $27,000 and which one are we going to believe even if we're using a perpetual system where we record the inventory reduction and related cost of goods sold as we go? We're going to believe the physical count, meaning we're going to make our adjustments, agree to the physical count and therefore we would have to write this down. We can see, of course, that we would have to make the difference here. We would have to credit this account in order to get it down to the $23,000. The other side of it, however, is something that we need to think through as well and often when we see something like this, we want to see and work it through by seeing the cost of goods sold calculation and that'll show us the other side of this transaction and all the components to it. It'll give us an idea if we see this in practice or in multiple choice questions, they could ask a lot of different components within the cost of goods sold formula. The cost of goods sold formula is going to be starting with beginning inventory. We get that from the general ledger. We can see where did the inventory start at the beginning of the time period. We're going to say $10,000 in this case. Purchases is what we bought in the inventory. Notice there's no guesswork with purchases. I don't have to guess how many units we bought. We bought what we bought. We don't have to guess about the purchase price. It is what it is. That's how much we're going to pay or half paid so far. And then we're going to say that if we add those two up, the $10,000 plus the $22,000, we have $32,000. We're going to call that goods available for sale. And that means that during the month or year, whatever time period we're talking about, we could have sold up to $32,000 worth of inventory. We can do the same calculation, by the way, in terms of units, but we're looking at dollars in this case. So we're saying $32,000 worth of inventory that we could have sold. Doesn't mean we have $32,000 worth of inventory at any given time throughout the month. It means that throughout the month, that's how much inventory we could have sold and has gone through our hands. We could have been selling it and buying it throughout the entire month. But we had $32,000 optimal or total that could have been sold. If we compare that then to the Indian inventory, which we're going to say to our physical count, this is going to be our physical count inventory, then we're going to say, well, this is what we could have sold during the time period. This is what we still have left. Typically, that would be then the cost of goods sold. Now note here, if we were doing a perpetual system, we would just say that's the cost of goods sold, and it would include, I mean, if we were doing a periodic system, we would have to do this calculation in order to get this cost of goods sold. And therefore, we would just assume that it was all sales that resulted in this cost of goods sold. However, when we're doing a perpetual system, we see here that we already are calculating this information, and we're recording the cost of goods sold, and it doesn't match what we came up to with our calculation here. We're different between that we have 9,000 here, of course, and 5,000 here, and that difference is most likely due to some type of inventory shrinkage, some type of theft, some type of loss, something like that that is going on here. So we're going to basically compare that cost of goods sold to what we have on the books for cost of goods sold. That adjustment then, that difference, that 9,000 minus what we have, the 5,000, the 4,000 then, is what we need to make an adjustment for. So this will show us the whole adjustment. We're going to, at the end of the day, we need to be at 23,000 in our ending inventory because that's our physical count, and we need the cost of goods sold to be at the 9,000 because that's what we calculated to be using our cost of goods sold calculation, and the adjustment that we're going to do in order to do that is this 4,000 adjustment. So if we were to record this then, we would say we need that adjustment. We're going to say that the cost of goods sold needs to go up to 9,000, so we will do the same thing to it as its balance, a debit to make it go up. So we're going to debit cost of goods sold, the other side of it then going to merchandise inventory. It having a debit balance, we need to make it go down because we had a physical count less than the amount reported, and therefore we're going to do the opposite thing to it and credit it. If we were to post that out, then we're going to say cost of goods sold is going to go from 5,000 up in the debit direction 4,000 to a total of 9,000. The merchandise inventory is going to start at a debit of 7,000. It's going to go down with a credit of 4,000, bringing us to the 23,000, that of course now matches out our 23,000 ending inventory, matches the physical count, and the 9,000 matches out to what our cost of goods calculation says it should. Now it might be a little confusing to some people, or it might question why would we be putting something that's going to be inventory shrinkage loss or theft or something like that into cost of goods sold given the definition that it says cost of goods sold, meaning it should be things that we sold that are accumulating here. Note that some of the rationale, one would be that the amount of shrinkage or loss or what not would be relatively small and therefore immaterial in relation to the rest of the numbers that we're dealing with and therefore not material to decision making. And so the easiest thing for us to do is to record it to the same account related to the inventory. So this is the inventory account, an asset account, the related expense account is cost of goods sold and therefore it would make sense to if we're just going to put it to an account, put it to the cost of goods sold. If it was significant, if it was significant to decision making, then we may want to put it in another account and say, hey, this is some significant loss that happened at this point in time, theft or shrinkage or some type of loss that we would might want to break out. But most of the time, we're just going to say, hey, it's immaterial, it's related to inventory, we're going to write it off in some way with the account we normally use to write off the use of the inventory in order to help us generate revenue. That then cost a good soul. Effect on the accounting equation, assets going down because inventory went down, liabilities staying the same. They haven't had any effect. And the equity is going down because the expense of cost of goods sold is going up, bringing the net income calculation down, also then bringing equity down. So the full, all the numbers would then look like this. So if we bring everything out, we're going to start it in balance. We entered something in balance, we end in balance. Here was our net income before this transaction. We are decreasing the net income by the 4,000 for the loss for the shrinkage that we recorded in the expense account of cost of goods sold, bringing the net income down to 98,000.