Question

In 2021, Adonis Industries changed its method of valuing inventory from the average cost method to the FIFO method. At December 31, 2020, Adonis’s inventories were $47.2 million (average cost). Adonis’s records indicated that the inventories would have totaled $63.2 million at December 31, 2020, if determined on a FIFO basis.

Ignoring income taxes, what journal entry will Adonis use to record the adjustment in 2021?

Answer 1

$16 million is inputed on credit side of adjustment journal

Step-by-step explanation:

Firstly, let us compare the FIFO method and the average cost method

Using FIFO method, we assign the cost of first acquired items to sales, while we assign the value of the closing stock to include the cost of recently acquired items.

In average cost method, the inventories have prices which are at the average of all available inventories. Average cost is obtained by dividing is total cost of goods available for sale by total units available for sale.

We proceed to calculate inventory value:

It is given that the average cost of inventory is $47.2million and inventory cost at book is $63.2million.

inventory value = Average cost of inventory value - Inventory cost at book = $47.2 - $63.2 millions = $16 million

We now proceed to the adjustment journal.

To fill the adjustment journal, we take note of the following;

Inventory is an asset. There is an increase in asset value. Therefore, it is debited.

Since Retained earnings are liability. There is an increase in liability value. Therefore, it is credited.

This means we put a value of $16 million on the credit side of the adjustment journal

Answer 2

Retained earnings under the Balance sheet

Explanation:

Making comparisons between the two inventory value when using FIFO or Average cost method=

63.0M - 47.1M = $15.9M

We see an increase in the ending inventory.

Thus, this increase in income has been unprecedented, and may not have been distributed to the shareholders of Adonis Industries. On the balance sheet journal entry this extra income would be indicted on the balance sheet on the retained earnings column for year 2021.