Question

In 20X2, the Robinson Company switched its inventory method from FIFO to average cost. Inventories at the end of 20X1 were reported in the balance sheet at $22 million. If the average cost method had been used, 20X1 ending inventory would have been $20 million. Ending inventory in 20X2 is $23 million using average cost, and would have been $26 million if the company had not switched from the FIFO method. The journal entry to adjust the accounts to reflect the average cost method would be:
A. Debit retained earnings and credit twentory for $2 million
B. Debit retained earnings and credit inventory for $3 million
C. Debit inventory and credit retained earnings for $1 million
D. Debit inventory and credit cost of goods sold for $3 million,

Answer 1

Answer:

A) Debit retained earnings and credit inventory for $2 million

Explanation:

Since Robinson's inventory was overstated by $2 million (= $22 million - $20 million) because of the previous inventory method (FIFO), when the new method, average cost, starts to be used the inventory must decrease by $2 million and retained earnings as well.

Retained earnings is an equity account and it decreases, therefore it should be debited.

Inventory is an asset account and it decreases, therefore it should be credited.