Question

Jones Corporation switched from the LIFO method of costing inventories to the FIFO method at the beginning of 2017. The LIFO inventory at the end of 20X0 would have been $80,000 higher using FIFO. Reported retained earnings at the end of 2016 were $1,750,000. Jones’s tax rate is 21%. Tax law requires a company using LIFO for tax purposes to use it for financial reporting as well. So, when Jones changes from LIFO to FIFO, it will have to do the same for tax purposes. Further, Jones must recognize taxable income equal to the amount by which it increases the inventory valuation when it makes the change. As a result, Jones will pay tax on an additional $80,000 of taxable income in 2017.

Required:
a. Calculate the balance in retained earnings at the time of the change (beginning of 2017) as it would have been reported had FIFO been previously used.
b. Prepare the journal entry to record the change in accounting principle at the beginning of 2017.

Answer 1

a. Calculate the balance in retained earnings at the time of the change (beginning of 2017) as it would have been reported had FIFO been previously used.

• $1,813,200

b. Prepare the journal entry to record the change in accounting principle at the beginning of 2017.

• Dr Inventory 80,000
• Cr Income taxes payable 16,800
• Cr Retained earnings 63,200

Step-by-step explanation:

inventory under FIFO would have been $80,000 higher, that means that COGS were overstated by $80,000 and net earnings were understated by $80,000.

retained earnings 2016 = $1,750,000

tax rate 21%

Dr Inventory 80,000

Income taxes payable 16,800

Retained earnings 63,200

Retained earnings = $1,750,000 + $63,200 = $1,813,200

When companies change from LIFO to FIFO, they must adjust their income statement and balance sheet in a prospective way because it will affect the future value of their accounts. But when a company changes from FIFO to LIFO, no adjustment is required.