Machino, Inc. began operations on January 1, 2014. During 2016, management decided to change from average-cost method to FIFO for its merchandise inventories. The change was effective at January 1, 2016. Management determined that cost of goods sold for each method would be:
Cost of Goods Sold
2016
2015
2014
Average cost method
$160,000
$130,000
$140,000
FIFO method
$120,000
$110,000
$115,000
The company's statements as reported under average-cost before implementing the accounting change for 2016, 2015, and 2014, respectively, are presented below. The income tax rate for Machino is 40%.
Machino, Inc.
Comparative Income Statements
For the Years Ended December 31
2016
2015
2014
Sales
$550,000
$475,000
$445,000
Cost of Goods Sold
(160,000)
(130,000)
(140,000)
Operating Expenses
(70,000)
(50,000)
(35,000)
Income before Taxes
$320,000
$295,000
$270,000
Tax Expense (40%)
(128,000)
(118,000)
(108,000)
Net Income after Tax
$192,000
$177,000
$162,000
Required:
1) Prepare the comparative income statements for Machino, Inc. after the change to FIFO.
2) Determine the after-tax cumulative effect in retained earnings at January 1, 2016.
3) Prepare the journal entry on January 1, 2016 for the change in accounting principle.
What will be an ideal response?
Answer:
1)
Machino, Inc.
Comparative Income Statements
For the Years Ended December 31
2016
2015*
2014*
Sales
$550,000
$475,000
$445,000
Cost of Goods Sold
(120,000)
(110,000)
(115,000)
Operating Expenses
(70,000)
(50,000)
(35,000)
Income before Taxes
$360,000
$315,000
$295,000
Tax Expense (40%)
(144,000)
(126,000)
(118,000)
Net Income after Tax
$216,000
$189,000
$177,000
*Restated
2) The first balance sheet presented under the new method is December 31, 2014. The cumulative effect after tax in retained earnings is computed as follows:
Cost of Goods Sold
2014
2015
Average cost
$140,000
$130,000
FIFO - new
115,000
110,000
Pretax cumulative effect
$25,000
$20,000
Tax (40%)
10,000
8,000
Cumulative effect after tax
$15,000
$12,000
The cumulative effect of the change is $15,000 plus $12,000 equals $27,000.
3) Journal entry on January 1, 2016 to effect the change in principle is:
Account
Debit
Credit
Inventory
45,000
DeferredTax Liability
18,000
Retained Earnings-Prior Period Adj. 27,000
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