Inventory shrinkage is reported in the financial statements as a reduction in the value of inventory on hand, which directly affects the cost of goods sold (COGS) and, consequently, the net income. When shrinkage in warehouse occurs, the inventory asset account is decreased, and an expense account (such as “Shrinkage” or “Inventory Shortage”) is increased, which is then reflected in the income statement as part of COGS or a separate line item, depending on the accounting policies of the company.