Question

On December 31, 2018, Grantham, Inc. appropriately changed its inventory valuation method to FIFO cost from weighted-average cost for financial statement and income tax purposes. The change will result in a $3,500,000 increase in the beginning inventory at January 1, 2018. Assume a 30% income tax rate. The cumulative effect of this accounting change on beginning retained earnings is

Answer 1

It was given that there is an accounting change in inventory valuation method from weighted average cost to FIFO.

As a result, the beginning inventory has been increased by $3,500,000. That implies, the net income has been decreased by $3,500,000

As we know that with effect of income tax of 30%, the remaining amount of net income should be carried to Retained earnings.

Income tax on increased net income = $3,500,000 * 30% = $1,050,000

Thus, the balance of net income being carried to Retained Earnings is $2,450,000 ($3,500,000 - $1,050,000). Therefore, the change in accounting change results in increase of $2,450,000 in the Retained earnings balance.