Change in inventory methods (LO 5-1)

Jones Corporation switched from the LIFO method of costing inventories to the FIFO method at the
beginning of 20X1. The LIFO inventory at the end of 20X0 would have been $80,000 higher using FIFO.
Reported retained earnings at the end of 20X0 were $1,750,000. Jones’s tax rate is 21%.

Tax law requires a company using LIFO for tax purposes to use it for financial reporting as well. So, when
Jones changes from LIFO to FIFO, it will have to do the same for tax purposes. Further, Jones must
recognize taxable income equal to the amount by which it increases the inventory valuation when it
makes the change. As a result, Jones will pay tax on an additional $80,000 of taxable income in 20X1.

Required:

Calculate the balance in retained earnings at the time of the change (beginning of 20X1) as it would have
been reported had FIFO been previously used.

Prepare the journal entry to record the change in accounting principle at the beginning of 20X

a. Calculate the balance in retained earnings at the time of the change (beginning of 20X1) as it would
have been reported had FIFO been previously used.

$1,813,200

b. Prepare the journal entry to record the change in accounting principle at the beginning of 2017.

Dr Inventory 80,000

Cr Income taxes payable 16,800

Cr Retained earnings 63,200

Explanation:
inventory under FIFO would have been $80,000 higher, that means that COGS were overstated by
$80,000 and net earnings were understated by $80,000.

retained earnings 2016 = $1,750,000

Error correction (LO 5-2)

Bettner, Inc., is a calendar-year corporation whose financial statements for 20X0 and 20X1 included
errors as follows:

Year

Ending Inventory

Depreciation Expense

20X0

$12,000 overstated

$22,300 overstated

20X1

8,000 understated

6,000 understated

Assume that inventory purchases were recorded correctly and that no correcting entries were made at
December 31, 20X0, or December 31, 20X1. The errors were discovered in 20X2, after the 20X1 financial
statements were issued.

Required:

Ignoring income taxes, prepare the journal entry Bettner would make in 20X2 to correct the errors.

Describe the content of the comparative periods in Bettner’s 20X2 financial statements. That is, how is
the correction reflected in the 20X2 financial report?

i. For the Understatement of Inventory - Rectification

Journal Entry Debit Credit

Inventory A/c $8,000

To Profit and loss adjustment a/c $8,000

ii. To Rectify overstatement of Depreciation Expense

Journal Entry Debit Credit

Profit and loss adjustment A/c $16,300

To Depreciation Expense $16,300

(22,300 - 6,000)

tax rate 21%

Dr Inventory 80,000

Income taxes payable 16,800

Retained earnings 63,200

Retained earnings = $1,750,000 + $63,200 = $1,813,200

When companies change from LIFO to FIFO, they must adjust their income statement and balance sheet
in a prospective way because it will affect the future value of their accounts. But when a company
changes from FIFO to LIFO, no adjustment is required.