Question

In year 2, Reynolds changes its inventory method from FIFO to the weighted-average method. If the weighted-average method would have been used in year 1, cost of goods sold would be $10,000 higher. Reynolds has an effective tax rate of 40%. What is the after-tax effect on retained earnings for year 1 for the change in accounting method

Answer 1

Retained earnings for year 1 would be lower by $6000

Step-by-step explanation:

A change in inventory valuation method resulted in higher cost of goods sold for the previous year.

This means had the new method of inventory valuation i.e weighted average been followed, the gross profit would have been lower by $10,000.

Had gross profits been lower by $10,000 , it would've led to net income being lower by $10,000. After deduction of 40% tax rate on such income, the after tax income would've been $6000 lower.

This further means the balance of retained earnings would've been reduced by $6000.