During 2016 (its first year of operations) and 2017, Batali Foods used the FIFO

Question

During 2016 (its first year of operations) and 2017, Batali Foods used the FIFO inventory costing method for both financial reporting and tax purposes. At the beginning of 2018, Batali decided to change to the average method for both financial reporting and tax purposes. Income components before income tax for 2018, 2017, and 2016 were as follows (S in millions): 2018 2017 2016 420 $390 S 380 (46) (40) (38) (62) (56) (52) (254) (250) (242) Cost of goods sold (FIFO) Cost of goods sold (average) Operating expenses Dividends of $20 million were paid each year. Batali's fiscal year ends December 31 Required: 1. Prepare the journal entry at the beginning of 2018 to record the change in accounting principle. (Ignore income taxes.) 2. Prepare the 2018-2017 comparative income statements. 3. &4. Determine the balance in retained earnings at January 2017 as Batali reported using FIFO method and determine the adjustment of balance in retained earnings as on January 2017 using average method instead of FIFO method

Explanation / Answer

(1).

Debit

Credit

Retained earnings

$30

     Inventory

$30

(For recording effect of additional cost of goods sold)

Explanation;

2017

2016

Cost of goods sold (FIFO)

$40 million

$38 million

Cost of goods sold (Average method)

$56 million

$52 million

Difference

16 Million

$14 million

Thus under Average cost method, cost of goods sold will be higher ($16 + $14) = 30 millions. So for adjusting this higher cost of goods sold we need to reduce balance of retained earnings and balance of inventory as well.

(2).

Comparative Income Statement

2018

2017

Revenues

$420

$390

Less: Cost of goods sold (Average method)

($62)

($56)

Gross margin

$358

$334

Less: Operating expenses

($254)

($250)

Net income

$104

$84

(3).

Balance in retained earnings at January, 2017 (FIFO method) = $80

Explanation;

2016

Revenues

$380

Less: Cost of goods sold (FIFO method)

($38)

Gross margin

$342

Less: Operating expenses

($242)

Net income

$100

Add: beginning retained earnings

$0

Less: Dividend paid

($20)

Balance in retained earnings at January, 2017 (FIFO method)

$80

(4).

Adjustment of balance in Retained earnings at January, 2017 (If Average method is used instead of FIFO method) = $14 (millions)

Explanation;

As it is given in the question that cost of goods sold is higher in case of average method. This cost of goods sold is higher by ($52 - $38) = 14 million. So in case of average cost methos net income will be lower by $14 million and ultimately it will result into lower of retained earnings by $14 million.

Debit

Credit

Retained earnings

$30

     Inventory

$30

(For recording effect of additional cost of goods sold)

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