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Accounting: FIFO/LIFO, Weighted Average, and Specific Identification 3 Views
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Transcript
- 00:00
Accounting Allah shmoop FYE Foe and Life Oh weighted Average
- 00:06
and Specific Identification Fife Oh life Oh are weighted average
- 00:14
and specific identification as in real life in the world
- 00:18
of accounting time and timing matter Costs of inventory change
- 00:23
all the time Not only is inflation always at work
Full Transcript
- 00:25
in the background but competitive dynamics of buyers and suppliers
- 00:28
change regularly And there's a big strike at a Pittsburgh
- 00:31
steel mine And all of a sudden the cost of
- 00:34
steel goes up a lot The strike ends and the
- 00:37
cost of steel plummets Companies that hold a meaningful amount
- 00:40
of inventory shelter themselves from this kind of volatility because
- 00:44
you can imagine the situation where a strike happens in
- 00:46
the key supply chain elements of AH bike manufacturer But
- 00:50
where the manufacturer holds a year's worth of inventory in
- 00:53
its warehouse Yeah you're not likely going to be too
- 00:56
nervous about a strike lasting more than a year because
- 00:58
all the workers would go bankrupt and starve and move
- 01:01
on Right So you'll allow your inventory reserves to be
- 01:04
depleted for awhile and replenish them when inventory costs go
- 01:08
back down after the strike Note that these volatile changes
- 01:11
which happens all the time are regularly mitigated by long
- 01:15
term contracts established from manufacturers and their component parts suppliers
- 01:20
That is it would be reasonable and rational for you
- 01:22
to contract with Hold the brakes dot com So you
- 01:25
pay thirty dollars per break unit and have a guaranteed
- 01:28
output of those units at a maximum price of thirty
- 01:31
two bucks a unit for say two years Otherwise you
- 01:34
might have been able to pay only thirty dollars for
- 01:37
that unit But in paying the extra two dollars for
- 01:40
the contract you're essentially buying supply line or supply lifeline
- 01:44
insurance in the unlikely event of a strike Essentially what's
- 01:47
happening here is that you are paying two dollars in
- 01:50
unit as a call option against inventory supply at thirty
- 01:54
bucks a share of its unit based cost Well this
- 01:57
structure is common vehicle through which most of large corporate
- 02:00
America ensures a steady stable supply of inventory so that
- 02:04
they can continue doing the voodoo They do Yeah Okay
- 02:08
So how does this concept apply to the application of
- 02:10
Fife Oh and life accounting Well let's imagine a world
- 02:14
where companies have not de risk their supply chains and
- 02:18
instead just allow the pricing or cost of their inventory
- 02:21
to remain volatile like it just floats with market prices
- 02:25
Let's presume there's a world where bike frames had massive
- 02:28
very ability in costs last month Frames cost one hundred
- 02:31
bucks each the previous month They cost one hundred fifty
- 02:34
dollars each month For that there were two hundred dollars
- 02:37
each And remember that your little bike company replenishes all
- 02:40
of its inventory immediately at the end of each month
- 02:43
in which it was depleted Still you sell a bike
- 02:45
for five hundred dollars this month All the other components
- 02:47
cost the same In the total cost your bike was
- 02:50
two hundred fifty dollars That two fifty presumes that the
- 02:53
cost of a bike frame was one hundred bucks or
- 02:55
forty percent of the total cost of the bike So
- 02:57
do you keep the hundred dollars from last month as
- 03:00
your price or do you keep one hundred fifty That
- 03:02
frame cost you last month or should you be using
- 03:06
the two hundred dollars price per frame that you incurred
- 03:09
two months ago Well there are a bunch of ways
- 03:11
to think about which cost structure to apply All our
- 03:13
legal But once you choose a method of accounting for
- 03:16
your inventory cost you have to stick with it If
- 03:19
you use life last in first out as your method
- 03:22
well you'd apply the last frame cost the last one
- 03:25
in or that hundred dollars a frame costs and your
- 03:27
accounting would be as outlined so that a bike unit
- 03:30
sold did indeed cost you two hundred fifty bucks But
- 03:32
if you use Fife oh first in first out While
- 03:36
the numbers would be completely different all of a sudden
- 03:38
the cost of the bike is no longer to fifty
- 03:40
But rather it reflects the first in our first purchased
- 03:44
bike frames which cost two hundred dollars apiece making the
- 03:47
total cost of your bike skyrocket from two hundred fifty
- 03:50
dollars a unit three hundred fifty dollars a unit Well
- 03:53
the same frames have been sold The same bike configuration
- 03:57
has been sold The same five hundred dollars has been
- 04:00
invade to buy the bike yet Now you're drawing from
- 04:02
early original inventory which carried a very high price per
- 04:07
unit thus showing much lower unit profit margins You know
- 04:12
per unit sold right Well why would a company want
- 04:14
to show lower profits Well of course there is a
- 04:17
little matter of taxes Taxes are assessed on profits not
- 04:21
revenues and in showing lower profits the cash flow of
- 04:25
the company doesn't change at all with the exception that
- 04:28
fewer cash dollars will go out the door at year
- 04:31
end to your friendly loving I Rs people if you
- 04:34
apply the earlier high cost bike frame numbers to your
- 04:37
expenses line in the income statement What this wrestling match
- 04:41
is common in successful companies Imagine that the first few
- 04:44
automobile frames that Tesla ordered were very small in number
- 04:48
and maybe they were ordering a thousand frames at a
- 04:51
time So they're early inventory gains none of the scale
- 04:54
advantage or volume discounting or robot ing of the same
- 04:58
frames they might be ordering today in buckets of fifty
- 05:02
thousand units Well there's no right or wrong answer in
- 05:04
applying five for life on companies that simply want a
- 05:07
blended average cost can do that as well Shockingly the
- 05:10
weighted average concept is a blend of all the cost
- 05:13
to create whatever inventory is currently housed in the given
- 05:17
warehouse Example your bike company ordered fifty frames of two
- 05:20
hundred bucks seventy five frames at one fifty and two
- 05:23
hundred frames His last month at one hundred while they're
- 05:25
total cost was forty one thousand two hundred fifty bucks
- 05:28
for three hundred twenty five frames So if you simply
- 05:31
divide out that money you spent to buy all those
- 05:34
three hundred twenty five frames you'll magically arrive at the
- 05:37
weighted average cost of a bike rain which is right
- 05:39
there One hundred twenty seven dollars Well typically each month
- 05:42
Then you would simply update your costs and volumes related
- 05:46
to inventory and the weighted average cost would move up
- 05:50
for down of it Well obviously the more inventory you
- 05:52
keep on hand the less the weighted average number will
- 05:55
move each month as you re stock inventory in you
- 05:59
know the supply chain kind of keep well Ah forthe
- 06:01
means of tracking inventory buying beyond Scifo in life Oh
- 06:05
and weighted average cost thing he's here is called specific
- 06:09
identification Well in this method individual buckets are tracked individually
- 06:14
and matched with specific sales So let's say you build
- 06:17
rockets for a living which take payloads of satellites test
- 06:20
monkeys and crazy billionaires who want to live forever into
- 06:23
space A given rocket might last for twenty launches and
- 06:26
it returns and is built in a custom manner such
- 06:29
that the revenues from its sale can easily be matched
- 06:32
with costs to build them like any component part or
- 06:35
input or system or guidance Telemetry grid that it took
- 06:39
toe launch that rocket into space The fuse lodge of
- 06:42
the rocket might have cost of eighteen million dollars to
- 06:45
frame in a fancy metal The cost of that fuse
- 06:47
Lodge for eighteen Mill would be specifically identified in match
- 06:50
to its eventual sales price of two hundred fifty million
- 06:53
dollars Right OK one more application for you before we're
- 06:56
done here Basket purchases Let's say you have a bike
- 06:59
parts supplier who comes to you asking if she can
- 07:01
supply the bike frame Two wheels and a brake system
- 07:04
all for one hundred twenty five bucks a unit This
- 07:06
is a cost savings of about twenty five dollars From
- 07:08
what you've been paying right you've been paying one fifty
- 07:10
Now you get to pay one twenty five for the
- 07:12
same thing Maybe there's even more savings If you wanted
- 07:15
to take her up on that deal well how would
- 07:17
you account for the bike frame as a unit going
- 07:19
forward Well suppose someone is in a race hits a
- 07:22
mailbox and the frame is twisted It needs to be
- 07:24
replaced Well how would you calculate the cost of that
- 07:27
frame It used to be easy when you paid a
- 07:29
hundred dollars ala carte for one frame but now you
- 07:33
have what's called a basket purchase or a bundle Yes
- 07:37
it bundles together a few different items but now you
- 07:40
have to take out the things that aren't the frame
- 07:43
in the one twenty five that you paid So what
- 07:45
do you do Well most likely you'd apply a total
- 07:48
cost percentage and then kind of back out the actual
- 07:51
costs after you'd taken your blindfold off and stop throwing
- 07:55
darts in the old days of frame represented seventy percent
- 07:58
of the cost of the three separate units when they
- 08:00
were bought Allah look hard so it would be rational
- 08:03
to just apply that same percentage under the basket purchase
- 08:06
system Then you would just apply a cost of point
- 08:08
seven times one Twenty five or get eighty seven fifty
- 08:11
now as the new cost of your frame Okay so
- 08:14
what we go through here We had for four different
- 08:15
ways of accessing inventory cost We had FIFA we had
- 08:19
life But we had the weighted average of our inventory
- 08:23
of what things work and we had specific identification and
- 08:26
we kind of extrapolated basket purchases inside of that So
- 08:30
that's it That's the group Let's figure out your inventory
- 08:33
costs and move on from there And while all this
- 08:36
is just one example of a you know a basket
- 08:38
case
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