Sure Mamma – here's the steps I take with the example from JRO, except I'm going to do it in the more conventional way instead of working backward to find the base (in his problem, he gave us the cost and the index)
Year 1: Base = 100,000
Year 2: Base = 120,000 (what was provided in JRO's problem was the cost of 128,400 and the index, see step #1)
Year 3: Base = 116,000 (what was provided was the cost of 145,000 and the index, see step #1)
Step #1: Find the Price Index
I think it's essential for you to know how to get the index.. that is the key to solving this problem. If you can remember the index equation, Current Year Cost/Inventory (Cost) BASE, you're at a good spot.
Solving the index for each Year:
Year 1: Base = 100,000 which means that the index is 1 – essentially this is your starting point, there is no increase or decrease here, so your index = 1.
Year 2: Base = 120,000 Cost = 128,400 —> Index = 1.07 (128,400/120,000)
Year 3: Base = 116,000 Cost = 145,000 —> Index = 1.25 (145,000/116,000)
Step 2: Applying your index to your base increase or decrease
The second thing you have to remember is that your index is then multiplied by your BASE increase or decrease (Base increase/decrease x index). Now this can get tricky when you have a decrease in your base… a decrease in your base uses the prior years base number, while an increase in your base uses the calculated base index for that year.
Solving the cost of your increase or decrease in BASE:
Year 1: Base began with 100,000 —> your index is 1.00 (you started here) —> 100,000×1.00 = 100,000
Year 2: Your BASE INCREASED (from Year 1), by 20,000 [ 100,000—>120,000 = +20,000 and therefore this number should be multiplied by your Year 2 index, noted above. (20,000×1.07 = 21,400 INCREASE)
Year 3: TRICKY
> Your BASE DECREASE (from Year 2), by 4,000 [ 120,000—> 116,000 ] = -4,000. With a decrease, you will use the PRIOR YEARS price index and NOT the index you calculated –> -4,000 decrease x 1.07 = 4,280 DECREASE
From Step 2, here is a summary of your calculations:
Year 1: 100,000×1.00 = 100,000
Year 2: +20,000 (in base from previous year)x 1.07 = 21,400
Year 3: -4,000 (in base from previous year)x1.07 = 4,280
Your total Year 3 inventory = 100,000 + 21,400 – 4,290 = 117,120.
To summarize your steps:
Step #1: Calculate your price index = Current Cost/Cost BASE
Step #2: Multiply your index by the increase or decrease from the previous year noting the following rules:
1. First year index number (i.e. 100,000 from above) is ALWAYS 1.00
2. base increase is multiplied by the index calculated in Step #1
3. If there is a decrease in your base from the previous year, multiple decrease by the index for the prior year
I know it's a lot, which is why i summed it up in several areas. Let me know if you have any questions – I had to put it up here quickly, so I hope I didnt miss anything.
AUD: DONE
FAR: DONE
BEC: DONE
REG: DONE
IM GOING TO BE A CPA!!!!!
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