ABC Recording Inventory pt 6 - YouTube

Welcome back to our intermediate financial  accounting class. Over the last few segments,  

we've been talking about inventory. The different  methods we to track it, why it's so important, the  

differences between periodic and perpetual, what  errors can do to our net income, and then we went  

through and did an example. A fun example, that  let us use some cool tables to calculate LIFO,  

FIFO, and weighted average, for both periodic,  and perpetual. In this next segment, we're gonna  

introduce a new method for doing inventory. Not  new in the sense that it's just been created, but  

new in the sense that you probably haven't seen  it before. It's one that we don't introduce until  

a intermediate accounting, but it's one that's  become very popular, because once gets the hang  

of it, it can move very very quickly, especially  compared to a perpetual LIFO system. Which, as we  

just did, can become...maybe not tedious because  it's all fun, but certainly time consuming. So  

let's take a look at the dollar value LIFO  method. What it does, and how it works. Basically,  

dollar value LIFO allows companies to combine  all of their inventory into one big calculation,  

instead of trying to go through, and keep track  of every single item, we're basically going to do  

one quick equation at the very end, and add that  in, or subtract that from what we had last period.  

There's really just two steps to this process.  The first is coming up with what we call a price  

index, and that's the relationship between the  current year prices, and what we were paying for  

this inventory when we decided to start dollar  value LIFO. The next step is to use that price  

index to actually create our LIFO layers. And once  I've done that, then it's a quick sum of all these  

layers, to get this year's ending inventory value.  Let's start by talking about this price index,  

then. This first part of the dollar value LIFO  system. There's really four simple steps to making  

this price index calculation. First: we have to  figure out the cost per product in the base year.  

The base year, again, is the year that we decided  to do dollar value LIFO. We're going to relate  

everything back to that base here, so that we can  put it all in common ground. If we don't do that,  

then we're trying to compare this year's prices to  last year's prices, to two years ago prices, to 20  

years ago prices, and it gets really convoluted.  If we can relate it all back to one year's prices,  

then it becomes really straightforward to see  how inventory has changed from this year, to last  

year, to the previous year, to 20 years, etc. So  we're gonna first go back and look at the cost per  

product back in that base year. Then we're gonna  figure out the cost per product this year. The  

year that we're trying to get a price index for.  Third, we're gonna multiply the number of units  

in ending inventory by the current year price,  and by the base year price per unit. Finally,  

we'll divide the current year total, by the base  year total, and the result will give us our price  

index. Let's take a look at an example, that I  think will make this much more clear. So this  

is BBEV. They decided to switch to dollar value  LIFO, and here's the information. In year one  

they had ten thousand units on hand, and they were  paying 15 bucks a unit for that inventory. In year  

two, they then had twelve thousand units on hand,  and in year two they were paying seventeen dollars  

a unit for that inventory. In year three, now  they're dropped to eleven thousand units, and the  

cost is now twenty two dollars a unit for their  inventory. So prices just keep getting bigger and  

bigger, which is pretty normal for an inflationary  system. So let's do our price index calculation,  

and we don't worry about it as much in year one.  If I wanted to compare year one prices to the base  

year one prices, I'm gonna get one. Because the  base here prices in year one, prices are the same,  

because year one is the base year. So I don't  worry about a price index for the current year,  

I'm just gonna know it's one hundred. That's how  we talk about a price index, or one. So, really,  

we want to work with year two, and again, the  first thing we're gonna do, step one, is to figure  

out the cost per unit at the base year. So my  base year cost was given to us, we were spending  

fifteen dollars per unit. Step two is to get the  cost per unit in the current year. Or in year two,  

and in year two we're now paying seventeen dollars  a unit. Step three, I'm going to multiply that by  

the number of units on hand at the end of year  two. So 12,000 units. This number. Not this one,  

this one. 12,000. So let's see, 15 dollars times  12,000, is a hundred and eighty thousand, and  

seventeen times twelve thousand is two hundred and  four thousand. So my price index will be the 204,  

divided by the 180. And that step four, and I get  one hundred and thirteen percent, or one point one  

three. The way we say a price index, by convention  is, 113. That's how we say it. But we need to  

know price index. If I see 113, I know it's 113  percent, or one point one three. Now let's take  

a look at year three, and we'll go through the  exact same process. So base year, current year.  

Base year, again, the price per unit was $15. In  the current year, in year three, the price is $22.  

Now let me just take a step back, as we look at  the problem again. Notice: I'm not comparing this  

year to last year. That's not what I'm doing. I'm  comparing this year to the base year. So I don't  

care about the year two numbers when I'm in year  three. I'm taking everything back to year one.  

That's the year that matters to me. That's my base  year. So in year 3, I have 11,000 units on hand.

So let's see, 11,000 times $15 is 165, and 11,000  times 22 is 242. So my price index will be 242,  

and 165, or 147. 147 percent, 1.47. Now when I  teach this in class, I always have somebody say:  

you know, you could just divide into 22 by the 15,  and you get that same 147. And the answer is: your  

right. As long as you only have one product, it  works just fine. When you have multiple products,  

you can't use that shortcut anymore. So if it's  just a one product system, go for it. Use the  

shortcut. But let me show you how it's different  when you use multiple products. Let's just assume  

that we work in a company that sells two units.  And let's do something clever. We'll call them  

A and B. And let's say that in year one, we had  10,000 units of A at $10 each, and 20,000 units  

of B at $20 each. And since it's year one, my base  year, my price index is a hundred. Or one hundred  

percent, or 1, or 1.00. In year two, I now have  15,000 units of A, and they're costing me 12 bucks  

each, and I have 10,000 units of B, and they cost  me $25 each. Well now they're growing differently,  

and this is what makes it so you can't just do  a price relationship. $10, to $12, or 25 to 20,  

because notice: this one's changed by $2, this  one's changed by five, and that's going to mess  

up my price index calculation. If they've both  grown by $2, I can still do that shortcut that  

we were talking about. So let's take a look  then at what the process would be to do the  

price index for year two. So base and current. a ,b. a, b.

Price in the base year was 10 and 20, price in  the current is 12 and 25, and I'm gonna multiply  

that by the numbers in year two. So fifteen  thousand, ten thousand, fifteen thousand,  

ten thousand. So let's see, ten times fifteen  thousand is a hundred and fifty thousand,  

twenty times ten thousand is two hundred thousand,  so if I had purchased all of these units back in  

year one, I'd have spent three hundred and fifty  thousand dollars buying them. If I had purchased  

all of these units in the current year, I would  have spent one hundred and eighty thousand buying  

item A, and two hundred and fifty thousand buying  item B, for a total of four hundred and thirty  

thousand. And now I can get my price index. 430,  divided by 350, gives me a price index of 123.  

And I can't get that by comparing the 12 to the  ten, or the 25 to the five. So it becomes more  

of a weighted average. And that's my calculation  for a price index. When we come back, we'll start  

talking about how to do the rest of the dollar  value LIFO system.

I'll see you then. Thanks.