Question

in 2025, the robinson company switched its inventory method from fifo to average cost. inventories at the end of 2024 were reported in the balance sheet at $22 million. if the average cost method had been used, 2024 ending inventory would have been $20 million. ending inventory in 2025 is $23 million using average cost, and would have been $26 million if the company had not switched from the fifo method. the company's tax rate is 25%. the effect of the change in method on 2025 income before taxes is a: multiple choice $1 million decrease. $3 million increase. $2 million decrease. $1 million increase.

Answer 1

The effect of the change in inventory method from FIFO to average cost on 2025 income before taxes is a $2 million decrease.

Step-by-step explanation:

The effect of the change in inventory method from FIFO to average cost on 2025 income before taxes is a $2 million decrease.

To calculate the effect of the change, we need to compare the ending inventories under both methods. In 2024, the ending inventory reported in the balance sheet was $22 million under FIFO. If average cost method had been used, the ending inventory would have been $20 million. Therefore, the change in method decreased the 2024 inventory by $2 million.

In 2025, the ending inventory is $23 million using average cost and would have been $26 million if the company had not switched from FIFO. So the change in method also reduced the 2025 inventory by $3 million.

The difference in ending inventory between the two methods, which represents the effect on income before taxes, is the sum of the decreases: $2 million + $3 million = $5 million. However, we need to consider the tax rate of 25%. Since the decrease in income before taxes is subject to taxes, the effect of the change on 2025 income before taxes is $5 million minus the tax amount of $5 million x 25% = $1.25 million. Therefore, the answer is a $2 million decrease.