Question

Presented below are income statements prepared on a LIFO and FIFO basis for Sunland Company, which started operations on January 1, 2019. The company presently uses the LIFO method of pricing its inventory and has decided to switch to the FIFO method in 2020. The FIFO income statement is computed in accordance with the requirements of GAAP. Sunland’s profit-sharing agreement with its employees indicates that the company will pay employees 10% of income before profit-sharing. Income taxes are ignored.
LIFO BASIS FIFO BASIS
2017 2016 2017 2016
sales 3000 3000 3000 3000
cost of good sold 1130 1000 1100 940
operation expenses 1000 1000 1000 1000
incomebefore profit sharing 870 1000 900 1060
porfit sharing expense 87 100 96 100
net income 783 900 804 960
Instructions:
A) If comparative income statements are prepared, what net income should Kenseth report in 2016 and 2017?
B) Explain why, under the FIFO basis, Kenseth reports $100 in 2016 and $96 in 2017 for its profit sharing expense.
C) Assume that Kenseth has a beginning balance of retained earnings at January 1, 2017, of $8,000 using the LIFO method. The company declared and paid dividends of $500 in 2014. Prepare the retained earnings statement for 2017, assuming that Kenseth has switched to the FIFO method.

Answer 1

Solution :

A.                                              Kenseth Company

                                   Income Statement (for the year ended)

                                                      2017        2016

Sales                                             3000        3000

Cost of goods sold                      1100           940

Operating expenses                    1000          1000

Income before profit sharing      9000         1060

Profit sharing expense                 96              100          

Net Income                                 $ 804          $ 960

The company must report $\ \ 100$ as profit sharing expense in 2016, even though, profit sharing of expense may be $\ \ 106$ if FIFO had been used in the year 2016.

B. The profit sharing of expense reflects the indirect effect of the change in an accounting principle. Under the SFAS No. 154, the indirect effects from period before the change are recorded in the year of the change.

In this case, profit sharing expense recorded in the year 2007 is composed of :

$ 900 x 10%     =   $ 90 (year 2017 under the FIFO)

$ 60 x 10%   = $ 6 (difference in the profit sharing for the year 2016)

       Net        = $ 96 (profit sharing expense for the FIFO in year 2017)

C.                              Retaining earnings statement of 2017

   Retained earning, Jan 1 as reported                                 $ 8000

   Cumulative effect of the change to $FIFO$ ($960 - $900)    $ 60

  Retained earnings , Jan 1, as adjusted                               $ 8060

  Add $:$ Net income                                                                   $\ \ 804$

 Deduct $:$  Dividends                                                                   $ 500

 Retained earnings, Dec 31                                                       $ 8364