This inventory method follows LIFO (last-in, first-out). Dollar value LIFO uses this approach with all figures in dollar amounts, rather than inventory units. As a result, companies have a different view of their balance sheets than under other methods, such as FIFO (first-in, first-out).
If inflation did not affect the statements of companies, dollar-value and non-dollar-value accounting methods would have the same results. However, because it does occur and thus costs change over time, the dollar-value method presents data that show an increased cost of goods sold (COGS) when prices are rising, and a lower net income. This can, in turn, reduce a company's taxes, but can make shareholders unhappy due to a lower net income on reports.
Dollar-value in the Decision-making Process
Managers apply the concepts of interest, future value, and present value in making business decisions. Therefore, accountants need to understand these concepts to properly record certain business transactions.
The time value of money
The concept of the time value of money stems from the logical reference for a dollar today rather than a dollar at any future date. Most individuals prefer having a dollar today rather than at some future date because:
- the risk exists that the future dollar will never be received; and
- if the dollar is on hand now, it can be invested, resulting in an increase in total dollars possessed at that future date.
Most business decisions involve a comparison of cash flows in and out of the company. To be useful in decision making, such comparisons must be in dollars of the same point in time. That is, the dollars held now must be accumulated or rolled forward, or future dollars must be discounted or brought back to the present dollar value, before comparisons are valid. Such comparisons involve future value and present value concepts.
The future value or worth of any investment is the amount to which a sum of money invested today grows during a stated period of time at a specified interest rate. The interest involved may be simple or compound.
Simple interest is interest on principal only. For example, USD 1,000 invested today for two years at 12 per cent simple interest grows to USD 1,240 since interest is USD 120 per year. The principal of USD 1,000, plus 2X USD 120, is equal to USD 1,240.
Compound interest is interest on principal and on interest of prior periods. For example, USD 1,000 invested for two years at 12 per cent compounded annually grows to USD 1,254.40 as follows: Principal or present value 1,000 x 0.12 = 120.00; Value at end of year 1: 1,120 x 0.12 = 134.40; Value at end of year 2 (future value) $1,254.40.