Rockwell Corporation uses a periodic inventory system and has used the FIFO cost

Question

Rockwell Corporation uses a periodic inventory system and has used the FIFO cost method since inception of the company in 1976. In 2013, the company decided to switch to the average cost method. Data for 2013 are as follows: Beginning inventory, FIFO (5,300 units @ $32) $ 169,600 Purchases: 5,300 units @ $38 $ 201,400 5,300 units @ $42 222,600 424,000 Cost of goods available for sale $ 593,600 Sales for 2013 (8,000 units @ $70) $ 560,000 Additional Information: a. The company's effective income tax rate is 40% for all years. b. If the company had used the average cost method prior to 2013, ending inventory for 2012 would have been $132,500. c. 7,900 units remained in inventory at the end of 2013. Required: 1. Prepare the 2013 journal entry to adjust the accounts to reflect the average cost method

2. What is the effect of the change in methods on 2013 net income?

Explanation / Answer

a.

Ending Inventory under FIFO for 2012 = $169,600

Ending Inventory under average cost for 2012 =$ 132,500

Decrease in ending inventory from change = $169,600 - $132,500 = $ 37,100

If ending inventory would have decreased, net income and retained earnings would have decreased. The reduction in retained earnings would reflect the after tax amount, i.e., $37,100 x (1 – 40%). Also the asset inventory would have decreased.

Account titles and explanation

Debit

Credit

Retained earnings ($37,100 x 60%)

$ 22,260

DTA ($37,100 x 40%)

$ 14,840

Inventory

$ 37,100

The reason for the DTA is that Rockwell is reducing its accounting income, but not its taxable income. Therefore, the accounting income will be less than taxable income. In the future, the difference will reverse, causing accounting income to be greater than taxable income

2.

Cost of goods sold under FIFO = (5,300 units * $32) + ($2,700 units * $38) = $272,200

Weighted Average cost per unit = Cost of goods available for sale/Units available for sale = $593,600/15,900 units = $37.33

Cost of goods sold under weighted average cost method = $37.33 * 8,000 units = $298,640

Hence change in net income = $272,200 - $298,640 = -$26,440

Hence 2013 net income shall decrease by $26,440

Account titles and explanation

Debit

Credit

Retained earnings ($37,100 x 60%)

$ 22,260

DTA ($37,100 x 40%)

$ 14,840

Inventory

$ 37,100

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