Question

Flay Foods has always used the FIFO inventory costing method for both financial reporting and tax purposes. At the beginning of 2021, Flay decided to change to the LIFO method. As a result of the change, net income in 2021 was $76 million. If the company had used LIFO in 2020, its cost of goods sold would have been higher by $7 million that year. Flay’s records of inventory purchases and sales are not available for 2019 and several previous years. Last year, Flay reported the following net income amounts in its comparative income statements: ($ in millions) 2018 2019 2020 Net income $ 76 $ 78 $ 80 Required: 1. Prepare the journal entry at the beginning of 2021 to record the change in accounting principle. (Ignore income taxes.) 3. What amounts will Flay report for net income in its 2019–2021 comparative income statements?

Answer 1

Answer:

Flay Foods

A Change in Accounting Principle, from FIFO to LIFO:

1. Journal entry at the beginning of 2021 to record the change in accounting principle (ignoring income taxes):

Debit Retained Earnings $7 million

Credit Ending Inventory $7 million

To record the change from FIFO to LIFO.

3. Amounts Flay will report for net income in its 2019 to 2021 comparative income statements:

                                                                        2019        2020         2021

Net Income                                                       $78          $80           $76

Less Cost of goods sold understated                             ($7)

Add Beginning inventory overstated                                                 ($7)

Modified Net Income                                       $78          $73           $83

Explanation:

A change in principle (e.g. inventory valuation method) requires the company to retrospectively apply the change to all prior reporting periods, as if the new principle had always been in place, unless it is impractical to do so.  Going from the above requirement, the 2018 and 2019 net income needed to be restated as a result of this change in accounting principle.  However, this is not practical from the information given.

The valuation of inventory impact on the Cost of goods sold and the profits differently, depending on the inventory method used.

FIFO stands for “First-In, First-Out.”  It is a method used for cost flow assumption purposes in the cost of goods sold calculation. The FIFO method assumes that the oldest products in a company's inventory have been sold first.

LIFO stands for "First-In, First-Out." The LIFO method assumes that the newest products in a company's inventory have to be sold first, instead of the oldest.  This is not practical in real life.  But, the LIFO method has some advantage during inflation, with rising costs.