Dollar-value LIFO is a modification of traditional LIFO method in which ending inventory is measured on the basis of monetary value of units instead of quantity of units held.
While learning LIFO and discussing its pros and cons, one issue was of LIFO’s incompatibility if entity is using FIFO for internal reporting purposes. This however, was solved with a workaround called LIFO reserve or LIFO Allowance. Another major issue with LIFO is delayering or better known as LIFO liquidation or erosion. To solve delayering problem, we use traditional LIFO’s modified approach called Dollar-Value LIFO.
It has two major benefits over traditional unit LIFO method.
- Unlike unit LIFO that group specific units based on quantities and respective rates. This makes calculation cumbersome. Dollar-value LIFO pools the items together and measure the value based on change in the total value of the pool and not the quantity.
- Unit LIFO method is prone to delayering because it records and maintains the specific quantity bought at specific rate as each individual layer. If old units are consumed it can seriously distort profit figures making it to appear more. Dollar value solves this as a result of pooling the goods on the basis of value and not the individual quality and rate. Also, the effect of inflation is reduced by properly accounting inflation effect in terms of money value.
Calculating values under dollar-value LIFO
One thing worth mentioning again is that dollar-value LIFO pools the inventory up. In simple words we will have one total figure of all the different types of inventory we like to have in one pool. One pool can have multiple types of items mostly similar.
Once the pool is established then comes the work to determine the base year and the price index to compute effect of inflation so that we can clearly find out if the increase in value of inventory is actually because of increase in quantity or simply inflation.
Once the actual increase is computed, it is then adjusted for current year prices and then we can know the total value of ending inventory under dollar-value LIFO.
Calculation steps for dollar-value LIFO are summarized as follows:
- Determine the base year value. It may be beginning of the year or any other year. Inflation index is measured with reference to this year.
- Compute the ending inventory values as per base year’s prices by applying inflation or price index
- Calculate the increase or decrease in value by comparing the values in step 1 and 2. This will give us the change in inventory because of change in quantity.
- Once the change is determined, reinstate the value as per current year’s prices.
- Compute the value of ending inventory by summing up the values of layers.
Example 1 – Dollar-value LIFO calculation
Suppose entity had a beginning inventory with total value of 100,000. By the end of the year total value of inventory held was 120,000. Assume further that prices has risen by 20% during the year.
Comparing 120,000 with 100,000 it seems that inventory has risen 20%. But is it really? Lets see after inflation effect is taken-off.
Adjust the closing inventory value for inflation as follows:
120,000 x 100 / 120 = 100,000
Once effect of inflation is adjusted, we can see that ending inventory value is equal to beginning inventory value meaning there has been no real change in quantity of units and increase in value was only because of inflation.
Therefore change is ZERO and after adjustment for current year prices i.e. 120% it will stay ZERO
Therefore under dollar-value method:
| Opening inventory – start of the year Increase during the year in real terms [0 x 120%] |
100,000 0 |
| Closing inventory – end of the year | 100,000 |
Example 2 – Dollar-value LIFO Calculation
ABC Inc. started the year with inventory worth 300,000. At the end of the year, warehouse manager reported that inventory worth 520,000 is held. If prices has risen by 25% during the year, what is the inventory cost under dollar-value LIFO method?
Solution:
As the prices has risen by 25% during the year. If we assume prices at the beginning of the year to be 100% then prices at the end of the year are 125%.
Step 1: Compute the value of ending inventory taking out the effect of inflation i.e. at beginning of the year prices as follows:
520,000 x 100/125 = 416,000
Step 2: Compare the figure calculated in step 1 with opening inventory value to determine the increase or decrease
= 416,000 – 300,000 = 116,000. Actual increase in value because of increase in quantity is this much.
Step 3: Gross up the change determined in step 2 as per current year’s prices i.e. 125%
= 116,000 x 1.25 = 145,000
Step 4: Now calculate the value of ending inventory by adding the value determined in step 3 in beginning inventory value:
| Opening inventory – First layer Increase during the year @ 125% – Second layer |
300,000 145,000 |
| Closing inventory as per doll-value LIFO | 445,000 |
Example 3 – Dollar-value LIFO Calculation
Following information is available for “Not-so-viable Inc.”
[table id=24 /]
Calculate the value of ending inventory of each year under dollar-value LIFO method
Solution:
First of all we have to determine ending inventories of each year at base-year prices:
[table id=25 /]
Inventory at the end of 2013:
Comparing the year end inventory values of 2012 and 2013 at base year prices we can see the change is only 100,000 (250,000 – 150,000)
Restating the change in prices as per 2013 i.e. 120% = 100,000 x 120% = 120,000
| Inventory at Base year |
Index | Inventory at Current year |
|
| First layer – 2012 inventory Second layer – Increase of 100,000 |
150,000 100,000 |
100 120 |
150,000 120,000 |
| 2013 inventory value | 250,000 | 270,000 |
Inventory at the end of 2014:
Comparing the base-year values of 2013 and 2014 we can see that values has decrease by 2,000 (248,000 – 250,000)
If there is a decrease in value, then it will be adjusted against the most recent layer. In our case it is second layer that was added in 2013 of 100,000 at base-year prices. After adjusted the decrease it will become 98,000 (100,000 – 2,000). After that we will restate the change as per 2013 prices i.e. 120% NOT 125%
| Inventory at Base year |
Index | Inventory at Current year |
|
| First layer – 2012 inventory Second layer – adjusted for 2000 decrease |
150,000 98,000 |
100 120 |
150,000 117,600 |
| 2014 inventory value | 248,000 | 267,600 |
Point to note here is that no new layer is added when inventory decreased. New layer is added ONLY if ending inventory at base-year prices is more than respective year’s beginning inventory at base-year prices.
Inventory at the end of 2015:
In 2015 the inventory value decreases further in terms of base-year prices by 33,000 (215,000 – 248,000). This again will be deducted from the most recent second layer. After adjusting the decrease balance of second layer will be 65,000 (98,000 – 33,000)
| Inventory at Base year |
Index | Inventory at Current year |
|
| First layer – 2012 inventory Second layer – adj. for 33,000 decrease |
150,000 65,000 |
100 120 |
150,000 78,000 |
| 2015 inventory value | 215,000 | 228,000 |
Inventory at the end of 2016:
Comparing the base-year values of 2015 and 2016 we see an increase of 95,000 (310,000 – 215,000)
As the ending inventory at base-year price level is more than the 2015 inventory therefore new layer will be added with the value of 95,000. This will be restated using 2016 price index i.e. 135% therefore increase of 95,000 in 2016 price level will be 95,000 x 1.35 = 128,250
| Inventory at Base year |
Index | Inventory at Current year |
|
| First layer – 2012 inventory Second layer Third layer – increase of 95,000 |
150,000 65,000 95,000 |
100 120 135 |
150,000 78,000 128,250 |
| 2016 inventory | 310,000 | 356,250 |
Example – Unit LIFO Vs Dollar-Value LIFO
All Things Company had the following inventory at the start of the year:
[table id=22 /]
During the year following purchases were made:
[table id=23 /]
By the end of the year company had 1000 units of Item 1 and 5000 units of Item 2.
Calculate the cost of units sold and cost of ending inventory under:
- Unit LIFO
- Dollar-value LIFO