How does the dollar-value LIFO method work, and how do you calculate inventory layers?
I came across a CFA Level I practice problem involving dollar-value LIFO and I was completely lost. I understand basic LIFO, but dollar-value LIFO seems to group inventory into pools and use price indices. Can someone explain the layer calculation with a clear numerical example?
Dollar-value LIFO (DV-LIFO) is a more practical variant of LIFO used when a company carries thousands of different inventory items. Instead of tracking individual units, DV-LIFO groups items into pools and measures changes in dollar amounts adjusted for price changes using a price index.
Core Concept: DV-LIFO converts current-year ending inventory to base-year dollars, then determines whether a layer was added or eroded, and finally re-inflates each layer back to the prices prevailing when that layer was added.
Step-by-Step — Thornfield Supply Co.:
Thornfield adopted DV-LIFO on January 1, 2023. Base-year inventory = $500,000. Price index = 1.00 in 2023.
| Year | Ending Inventory (Current $) | Price Index |
|---|---|---|
| 2023 (base) | $500,000 | 1.00 |
| 2024 | $588,000 | 1.05 |
| 2025 | $672,000 | 1.12 |
| 2026 | $630,000 | 1.15 |
Step 1: Convert to base-year dollars
| Year | Current $ | ÷ Index | Base-Year $ |
|---|---|---|---|
| 2023 | $500,000 | 1.00 | $500,000 |
| 2024 | $588,000 | 1.05 | $560,000 |
| 2025 | $672,000 | 1.12 | $600,000 |
| 2026 | $630,000 | 1.15 | $547,826 |
Step 2: Identify layers added or eroded
| Year | Base-Year $ | Layer Added (Eroded) |
|---|---|---|
| 2023 | $500,000 | Base layer: $500,000 |
| 2024 | $560,000 | +$60,000 |
| 2025 | $600,000 | +$40,000 |
| 2026 | $547,826 | −$52,174 |
In 2026, inventory declined by $52,174 in base-year dollars. This erodes the most recent layers first (LIFO): the 2025 layer ($40,000) is fully eroded, and $12,174 of the 2024 layer is eroded.
Step 3: Re-inflate remaining layers
| Layer | Base-Year $ | × Index | DV-LIFO Value |
|---|---|---|---|
| 2023 base | $500,000 | 1.00 | $500,000 |
| 2024 remainder | $47,826 | 1.05 | $50,217 |
| Total | $550,217 |
Key Points:
- Layer erosion is permanent — once a LIFO layer is liquidated, it does not come back. Future increases create new layers at the new year's price index.
- LIFO liquidation — if layers from very old years get eroded, those low-cost layers flow through COGS, temporarily boosting gross profit (a red flag for analysts).
- DV-LIFO is primarily a US GAAP concept since IFRS prohibits LIFO entirely.
Practice more DV-LIFO problems in our CFA Level I question bank.
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