Why will the traditional LIFO inventory costing method and the dollar-value LIFO inventory costing method produce different inventory valuations if the composition of the inventory base changes?
The unit LIFO inventory costing method is applied to each type of item in an inventory. Any type of item removed from the inventory base (e.g., magnets) and replaced by another type (e.g., coils) will cause the old cost (magnets) to be removed from the base and to be replaced by the more current cost of the other item (coils).
The dollar-value LIFO costing method treats the inventory base as being composed of a base of cost in dollars rather than of units. Therefore, a change in the composition of the inventory (fewer magnets and more coils) will not change the cost of inventory base so long as the amount of the inventory stated in base-year dollars does not change.
(a) LIFO layer.
(b) LIFO reserve.
(c) LIFO effect.
(a)
LIFO layer—a LIFO layer (increment) is formed when the ending inventory at base-year prices exceeds the beginning inventory at base-year prices.
(b)
LIFO reserve—the difference between the inventory method used for internal purposes and LIFO.
(c)
LIFO effect—the change in the LIFO reserve (Allowance to Reduce Inventory to LIFO) from one period to the next.
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