ABC Recording Inventory pt 7 - YouTube

Welcome back to our intermediate Financial Accounting class. Over the last

few segments, we've been talking about inventory: what it is, why it's important,

and how to track it. We've talked about all the different options companies have,

periodic, perpetual, LIFO, FIFO, weighted average, and we've done some examples of

all of those common inventory methods. Now in the last segment, and in this

segment, we're transitioning to a newer method called dollar value LIFO. In the

last segment, we talked about what it is, and we talked about how to do the first

part of the process, by calculating a price index. Now we get to talk about the

rest of it, and I should say, as we get started here: because dollar value LIFO

has become so common, the steps on how to do it are one of our key concepts, so

please make sure you're comfortable with these as we move forward. So here are

steps to the dollar value LIFO method. First we're going to calculate the value

of inventory at each end of your price, so I'm not keeping track of all of my

values and inventory going in and out at all, I'm just saying okay, at the end of

the year, if I were to buy all this stuff, it would have cost me this much, and my

current prices, that's step one. Step two, we're going to calculate the value of

the inventory back at the base year. So if I had purchased all this stuff back

when I started dollar value LIFO in my base year, what would it have cost me

then? and the easy way to do that, instead of going through all of my inventory and

recalculating it, is to use the price index that we calculated last time. We

simply take the current value price, and divide by the price index, and that'll do

it. That'll deflate the value from this year's price to our base year price.

Third, we're going to calculate the value of any new layer of inventory by looking

at the previous layers. Now before we get into the step, you have to remember the

concepts of layers, do you remember? LIFO layers are all the old inventory

that have built up over time. So I bought a bunch of units at $10 each, that's one

layer, then I bought some units at $12 each, they're a little newer, then some

units at $15 each, and $20 each, and $50 each, or whatever, and each of those

layers slowly builds up as we don't sell everything we buy. And that's what we're

talking about here. We look at all the old layers that

we've already shown, hey, these layers already in there, now there's a

new layer that I'm adding. Now probably the best way to think about this, believe

it or not, is to think about ice cream. I know that seems really weird, but it

really is a good way to think about this process. Do you remember when you were a

kid getting that double-decker ice-cream cone, where they put two scoops on your

cone, and (maybe you dreamed like I did) three or four scoops, I mean, this huge

tower of ice cream, we probably saw the cartoons, or Sesame Street characters

with these big tall stacks of ice cream. Well, the same idea is what

we're using here in dollar value LIFO. So imagine we've got an ice cream cone, and

I go back to my base year prices, and I realize that I have this much ice cream

at base year price, that's my total, and then I go back and I take a look and I

say, well, I have this much ice cream from the first year, that's my first level, and

I have this much ice cream, or inventory, from the second year, and I have this

much inventory from the year after that, and I have this much inventory from last

year, so this year I must have added THAT scoop of ice cream. That is step three: it's

going back through all the other scoops of ice cream, or layers of inventory,

figuring out what's already there, because remember, it's LIFO, so we assume all the

old ice cream is still there, we're just eating from the top down, so I figure out,

at the end of the year, I've got this much more ice cream than I did before, so

I've added that much of a layer, and now I've got all these different layers of

ice cream. And that brings us to step four, where we take each layer and

multiply by its price index and we re- inflate from base year prices to the

price we actually would have paid in years one, two, three, four, and then this

year, year five. Finally, our last step is we're going to add up all of those

prices at their actual values, what we really paid for that inventory in each

of the separate years, and that gives us our ending inventory value.

Pretty cool, huh. Think about it like ice cream, and it makes a lot more sense.

I think. At least it does to me. Let's take a look at an example, that I

hope will solidify this. So with this table, I've done step one for you. These

are the end of your prices. This is what I would have paid for all of my

inventory if I had purchased it at the end of these years. So this is step one,

we're not to the ice cream scoops yet, this is just values at the end of each

particular year. Step two is to divide by the price index, and you can see I've

calculated this for you as well, and remember a price index we call it 100,

110, 115, but it's really 1.0, 1.1, 1.15, etc. So to get to step 2, we're going to

divide. So 10,000 divided by 1 is still 10,000, 55,000 divided by 1.1 is 50,000,

and we could go on and do the rest of these, but let's just pause there and

take a look at the value of inventory at these first two years. So I'm gonna make

a table to help me keep track of my dollar value

LIFO, and we're gonna have a column for year, we're gonna have a value of the

inventory at the base year price, if you want to think about it this way, this is

the total ice cream right here from step two, next we're gonna have a layers at

base here

and these are the scoops of ice cream now, so we've got total ice cream, and now

the scoops, then we're gonna put back in our price indices, and we're gonna

multiply the layers of base here times the price index for each year, and that's

gonna give us our layers at ending

prices, or the end of each year, and finally we'll calculate a total ending

inventory. So let's start with year one, the simplest of all. In year one, the

inventory at base year was ten thousand, and you can just imagine, right, in that

very first year I have one scoop of ice cream, and that's all I got, so my layer,

my scoops, is just that one scoop: 10,000 units. My price index is a hundred, or 1.0,

so if I multiply ten thousand by one, I get the same ten thousand, and my

inventory value would be ten thousand. Just like that. Year two, now, my inventory

at base year, or the total ice cream, that's what we get from step two,

so it's this number: $50,000. So if we think about our ice cream, I have a ten

thousand dollar scoop, and now if my total is fifty thousand, and I have a 10

thousand dollar scoop, then this scoop must be for forty thousand dollars, so I

have a $40,000 scoop that I'm adding in. My price index for the year is one point

one, so forty thousand times one point one is forty four thousand. So now I have

two scoops of ice cream, it cost me $10,000 to buy the first

scoop, and forty four thousand to buy the second scoop, now that I've gotten it

back into its actual prices, so my total inventory value at the end of year two

is $54,000. That's how dollar value LIFO works. Let's

take a look at another; here, let's do year three. So I take the 70,000, divided

by one point one five, and I get a value of 60 thousand eight hundred and seventy,

so we go back to our table, year three, let's do our ice cream scoop again, sixty

thousand, eight seventy, I have a ten thousand dollar scoop, I have a $40,000

scoop, and the new scoop, we put this 60 thousand, eight seventy here, so it must

be sixty thousand eight seventy, minus the 40, minus the ten, so I've added a new layer,

or a new scoop of ice cream, of ten thousand eight seventy... if I'd purchased it

back when I started dollar value LIFO. But I didn't buy it then, instead I

bought it in year three. So I have to change this price back to the year three

prices, so ten thousand, eight seventy times 1.15, or 115, twelve thousand five

hundred, if I take the ten, plus the forty four, plus the 12 five, my ending

inventory at the end of the year, all three of

these, would be sixty six five. Now we've walked through this process three times,

hopefully it's making sense, what I'd like you to do is stop here and do year

floor, and then come back and check your numbers.

Here's our very first two steps, we start with step one, I did

that for you, gave you the $90,000, we take the 90 thousand, divided by the

1.25, and that gives us base year value of this $90,000, of inventory of

seventy-two thousand dollars. That's my total amount of ice cream. So I take that

to my other table, seventy two thousand is my total ice cream, I've got scoops

already totaling up to sixty thousand eight seventy, all these old layers, so I

would have added a new scoop of ice cream of eleven thousand one thirty. I

take the eleven one thirty, times the one point two five, that gives me this

thirteen thousand, nine twelve. I add all of those ending inventory values

together, and I end up with a total ending inventory in year four of eighty

thousand, four hundred and twelve. Do you see how this can become really simple

once you get the hang of it? I'm not keeping track of all those different

line items, and sales, and purchases, and in, and out. No, it's a very

straightforward calculation that I'm just adding in one new line each time I

add a layer. Now the other thing we need to look at here, is sometimes we don't

keep all of our ice cream. So I've had four scoops, and now I eat the top two, so

I've dropped the value of my inventory quite a bit. I'm liquidating my layers.

And we talked about how companies might do that purposely, or unintentionally,

and that gives them a higher net income, because they're using up this older

stuff that we paid less for. Same thing that happened with dollar value, we can

liquidate the layers, and we need to take a look at what happens when we end up

with less ice cream than we started with. Let's take a look at year five. We take

the ninety five thousand, divided by the 135, and we end up with seventy thousand,

three hundred and seventy. You can see right away, value has dropped. We were at

seventy two, now we're down to seventy thousand, three seventy, obviously we've

eaten some of our ice cream. So let's take a look at our table here in year

five, put in our seventy thousand, three seventy, and let's take a look at our ice

cream scoop here. So we started the period with ten

thousand, forty thousand, ten thousand eighty seven, and eleven one thirty, and

now I go to measure my ice cream, and I realize I'm right here at seventy

thousand three seventy. Well, because it's LIFO, this ice cream is still here, and

this ice cream is still here, and this ice scream is still here, but only part

of that ice cream is still there, so I need to show that in my calculation. The

way I do it, is by simply dropping the value of the layers that are now gone. So

if I had ended up with $9,000, then I would have dropped my ice cream cone all

the way down to here, and I would have said, well, all of this is gone, but I

still have this $9,000 scoop of ice cream so let's take a look at this, then.

A little bit different at this point, I have to redo the whole table once I

start liquidating, you don't have to, but it's usually easier that way. So I still

have the $10,000 scoop, and I sell up the $40,000 scoop, and I still have this ten

thousand eight seventy scoop. What I don't have, is the full eleven 130. What

have I got instead, well the easy way to figure that out is to take ten thousand,

plus 40, plus ten eight seventy, minus the seventy thousand three seventy, and that

gives you the value of this new, or this partial ice cream scoop: 9,500. Again,

seventy thousand 370, minus the scoops I know we're still there, so I've dropped

this scoop, I still have part of that, but I've dropped it, and I'm gonna

multiply by my price index, what price index do I use? It was 135 for this

year, but it was 125 for last year, which of those two numbers do I use? Well the

answer is: I use the 125, because that's when I bought it. Not this year's number,

I didn't buy anything this this year, I don't have a layer, or a scoop of ice

cream, so I go back to the the time when I actually bought it. So

125, and now I can re-inflate these, so this stays 10,000, and this becomes

44,000, and this is 12,500, and 9,500, times 1.25 is 11,875, if I add those four

numbers up, my total at the prices I actually paid, 78,375. Now

we did an example here, what if I'd liquidated all of my layers up to just

$9,000? Well, that would mean that this is gone, and this is gone, and this was gone,

and this would go to 9,000, so this would go to 9,000, and that would be 9,000, so

same exact process, I just figure out how much ice cream is gone, and I just look

for my layers, right? I eat the ice cream from the top down, so what ice cream

scoops are left, keep those layers in my process. Now to

kind of round this off, let's add one more year to this, just so we can see

what happens after we've done a liquidation. So let's assume, I don't have

a lot of space here, but I'm gonna try to slip this in, let's assume that in year 6,

you had 110,000, and the price index was 140, so let's see, 110 divided by 1.4

gives me 78,571. So I've increased again, and added a new

scoop of ice cream. So let's go back to our table, here's your 6: 78,571, I've got

all these red marks, but we're working with the purple one, so we still have the

10,000, the 40,000, 10, the 950, etc. What's the value of my new scoop of ice cream?

Well I take the 78,571, minus all of these values, or you can draw your ice

cream, what ever works best for you, and I end up

with a new value of 8,201, that's the new scoop of ice cream. One

really important rule here: is that once a layer is gone, it IS gone. You can't get

it back just like eating ice cream. Once you've eaten it, it's not coming back

onto your ice cream cone. It's gone, you used it up. So same idea

here, so I can't say: "well, I've got $8,200, here is my new layer, why don't I take

that 9500, and kick it back up to the eleven one thirty first, and then I'll

add a new scoop of ice cream?" Can't do that. I have to just add a brand new

scoop on top of this now smaller scoop that I made by eating, or liquidating,

part of that layer. So in this case I take the 8,201, times not the 135 from

year five, that year is gone, I didn't add a layer, I'll never use its price index

again, I use the new year's price index. So I'm going to take the 8,201 times the

14,0 and I'm going to get 11 481, give or take a little bit, because I'm

rounding, but if I take the 78 375 from last year, I add that 11,480, I get 89

850. And that's my new ending inventory value. That wraps up our dollar value

LIFO example, hopefully you can see here how easy this is when I add a layer. It's

just a quick calculation, and I'm done. It can be very fast to use this method once

you get the hang of it, it's even faster. When you start to liquidate layers,

it's certainly faster than using a normal perpetual inventory system, and keeping

track of every dollar in and out, and back and forth, so this has become a

popular and common method. When we come back, we're gonna wrap up our discussion

of inventory. We've done all these examples, all these neat ideas, it's time

that we wrap this up.

So I will see you then.