Question

On January 1, 2015, Frost Corp. changed its inventory method to FIFO from LIFO for both financial and income tax reporting purposes. The change resulted in a $700,000 increase in the January 1, 2015 inventory. Assume that the income tax rate for all years is 30%. The cumulative effect of the accounting change should be reported by Frost in its 2015

1) retained earnings statement as a $490,000 addition to the beginning balance.
2) income statement as a $490,000 cumulative effect of accounting change.
3) retained earnings statement as a $700,000 addition to the beginning balance.
4) income statement as a $700,000 cumulative effect of accounting change.

Answer 1

The cumulative effect of Frost Corp's accounting change from LIFO to FIFO, which resulted in a $700,000 increase in inventory, should be reported as a $490,000 addition to the beginning balance of retained earnings after accounting for a 30% tax rate.

Step-by-step explanation:

The student asked a question regarding how the cumulative effect of an accounting change from LIFO to FIFO should be reported in Frost Corp's financial statements when the change resulted in a $700,000 increase in inventory. Given an income tax rate of 30%, the cumulative effect of this change on retained earnings would be the inventory increase minus the tax effect on this increase. This is calculated as $700,000 less 30% of $700,000 ($210,000), which equals $490,000. Therefore, the correct way to report this would be to show a $490,000 increase in the beginning balance of retained earnings, not on the income statement.