At the end of the year, assume the balance of Inventory is $109,225 and physical inventory on hand is $106,320. The adjusting journal entry to record shrinkage will be:

a. a $215,545 debit to Cost of Goods Sold and a $215,545 credit to Inventory.
b. a $109,225 debit to Inventory and a $109,225 credit to Cost of Goods Sold.
c. a $2,905 debit to Cost of Goods Sold and a $2,905 credit to Inventory.
d. a $2,905 debit to Inventory and a $2,905 credit to Cost of Goods Sold.

The answer is C. a $2,905 debit to Cost of Goods Sold and a $2,905 credit to Inventory

Explanation:

Here, the physical inventory which is a current asset is lower than the inventory balance in the book. This can happen as a result of theft or error in filling the book.

The reality should be considered. The value of inventory($109,225) on the book balance should be reduced to the value of physical cash($106,320).

The difference should be calculated. The difference here is $2,905

So we debit cost of goods with this value and credit physical inventory on hand.