Question

3 The Aledo Company, which has only been in business since 2017, decided to change from the Average Cost to the FIFO inventory cost flow assumption for financial reporting purposes. The following data are available in regard to its pretax operating income and cost of goods sold:

                        Average Cost             

                        Net Income                  FIFO Income

Year                As Reported                Net Income

2017                $40,000                        $48,000

2018                46,000                        56,000

2019                  50,000                        62,000

Required

1. Ignoring tax effects. Compute the cumulative effect of the change of accounting principle at the beginning of 2019 and record the journal entry to reflect the change.

2. What net income would be reported in the financial statements presented for the years prior to 2019 after the accounting change?

Answer 1

Solution:

Part 1:

A change in accounting principle results when an entity adopts a generally accepted accounting principle different from the one it used previously. The entity adopts a “retrospective” approach to accounting principle changes. It defines retrospective application as applying a “different accounting principle to prior accounting periods as if that principle had always been used.

We need to calculate the cumulative effect of Net Income on Retained Earnings at the year end 2019

Change in Accounting Principle
Year	Average Cost Net Income As Reported	FIFO Income Net Income	Increase or (Decrease) in Net Income	Cumulative Increase in Retained Earnings
2017	$40,000	$48,000	$8,000	$8,000
2018	$46,000	$56,000	$10,000	$18,000
2019	$50,000	$62,000	$12,000	$30,000

The adjustment entry in 2019 to implement this change in accounting principle would be as below:

	Debit	Credit
Inventory	$30,000
Retained Earnings		$30,000
(Being change in accounting principle is recorded retrospectively)

Part 2 - Net Income would be reported in the financial statements presented for the years prior to 2019 after the accounting change

Year	Net Income to be Reported in the financial statements prior to 2019 after the accounting change (As per FIFO Income)
2017	$48,000
2018	$56,000

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