Question

Knowledge Check 01 Melas Company changed from the LIFO to the FIFO inventory costing method on January 1, Year 3. Inventory values at the end of each year since the inception of the company are as follows: FIFO LIFO Year 1 $ 195,000 $ 177,500 Year 2 390,000 355,000 Ignoring income tax considerations, prepare the appropriate journal entry, dated January 1, Year 3, to report this accounting change. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

Answer 1

Answer:

An adjustment to retained earnings is necessary when when there is a change from LIFO to FIFO.

Calculating the effect on retained earnings:

- In the year 1 company followed LIFO and recorded ending inventory at $177500. Had it followed FIFO it would have recorded at $195000. So there would be increase in income of $17500 (195000 - 177500).

- In year 2 it followed LIFO and recorded opening inventory at $177500 and closing inventory at $355000 and thereby recording Net closing stock of $177500 (355000 - 177500). Had it followed FIFO it would have recorded a net stock of $195000.(390000-195000). So there would be increase in income by of $17500 (195000 - 177500).

So in total of 2 years there would be an increase of $35000 Net income i.e., Retained earnings and increase in stock value of $35000.

The journal entry is:

Inventory A/c Dr $35,000

To Retained earnings A/c $35,000

Explanation: