Question

In 2018, the Barton and Barton Company changed its method of valuing inventory from the FIFO method to the average cost method. At December 31, 2017, B & B’s inventories were $32 million (FIFO). B & B’s records indicated that the inventories would have totaled $23.8 million at December 31, 2017, if determined on an average cost basis. Ignoring income taxes, what journal entry will B & B use to record the adjustment in 2018? (If no entry is required for a transaction/event, select "No journal entry required" in the first account field. Enter your answers in millions rounded to 1 decimal place (i.e., 5,500,000 should be entered as 5.5).)

Answer 1

Answer:

In Barton and Barton Company's general journal, entry required include:

Debit Retained Earnings Account with $8.2 million

Credit Opening Inventory with $8.2 million

Being reversal of overstated inventory due to change from FIFO to Average cost method.

Explanation:

The debit entry to the Retained Earnings Account will reduce the balance by $8.2 million.  The effect of overstating the closing inventory is overstatement of the net income because the cost of sales was understated as a result of the inventory overstatement.

The credit entry to the Opening Inventory reduces the balance to the new balance based on the average cost method of $23.8 million.

The FIFO cost method or First-In, First-Out method is an inventory costing method that assumes that goods that were bought first were the ones to be sold first.  The inventory cost is therefore valued with the most recent quantity and cost price.

On the other hand, the Average Cost Method, also called the Weighted Average Cost Method, calculates the inventory cost by adding all the period's inventory and dividing it by the quantity for the period.  This gives an average cost which is in turn used to multiply the quantity of inventory at the end of the period to obtain the inventory cost.

Both methods are estimates that produce different results and affect the reported net income differently.  There is always the need for consistency in choosing the method to apply so that reported net income is not unduly distorted.