Question

Aquatic Equipment Corporation decided to switch from the LIFO method of costing inventories to the FIFO method at the beginning of 2021. The inventory as reported at the end of 2020 using LIFO would have been $53,000 higher using FIFO. Retained earnings at the end of 2020 was reported as $710,000 (reflecting the LIFO method). The tax rate is 35%.
Required:
a. Calculate the balance in retained earnings at the time of the change (beginning of 2009) as it would have been reported if FIFO had been used in prior years.
b. Prepare the journal entry at the beginning of 2009 to record the change in principle.

Answer 1

Answer:

a. The balance in retained earnings at the time of the change (beginning of 2021) as it would have been reported if FIFO had been used in prior years is $744,450.

b. Debit Inventory for $53,000; Credit Income tax payable for $18,550; and Credit Retained earnings for $34,450.

Explanation:

Note: There is an error in the date stated in the requirements of the question as they are different from the date in the body of the question. The requirements are therefore restated with the correct date before answering the question as follows:

a. Calculate the balance in retained earnings at the time of the change (beginning of 2021) as it would have been reported if FIFO had been used in prior years.

b. Prepare the journal entry at the beginning of 2021 to record the change in principle.

The explanation of the answer is now given as follows:

a. Calculate the balance in retained earnings at the time of the change (beginning of 2021) as it would have been reported if FIFO had been used in prior years.

The effect of LIFO is to overstate the cost of goods sold and understated the retained earnings.

The balance in retained earnings at the time of the change (beginning of 2021) as it would have been reported if FIFO had been used in prior years can therefore be determined as follows:

Inventory understatement net of tax = $53,000 * (100% - Tax rate) = $53,000 * (100% - 35%) = $34,450

Therefore, we have:

Retained earnings under FIFO = Retained earnings as reported + Inventory understatement net of tax = $710,000 + $34,450 = $744,450

Therefore, the balance in retained earnings at the time of the change (beginning of 2021) as it would have been reported if FIFO had been used in prior years is $744,450.

b. Prepare the journal entry at the beginning of 2021 to record the change in principle.

The journal entry will look as follows:

Details                                                       Debit ($)        Credit ($)    

Inventory                                                    53,000

Income tax payable (53,000 * 35%)                                18,550

Retained earnings                                                            34,450

(To record the change in principle.)