Question

Presented below are income statements prepared on a LIFO and FIFO basis for Novak Company, which started operations on January 1, 2016. The company presently uses the LIFO method of pricing its inventory and has decided to switch to the FIFO method in 2017. The FIFO income statement is computed in accordance with the requirements of GAAP. Novak’s profit-sharing agreement with its employees indicates that the company will pay employees 10% of income before profit-sharing. Income taxes are ignored. LIFO Basis FIFO Basis 2017 2016 2017 2016 Sales $2,910 $2,910 $2,910 $2,910 Cost of goods sold 1,130 1,040 1,050 990 Operating expenses 1,050 1,050 1,050 1,050 Income before profit-sharing 730 820 810 870 Profit-sharing expense 73 82 86 82 Net income $657 $738 $724 $788 Answer the following questions.

If comparative income statements are prepared, what net income should Novak report in 2016 and 2017? (Round answers to 0 decimal places, e.g. 125.) 2017 2016 Net income $ $

Assume that Novak has a beginning balance of retained earnings at January 1, 2017, of $738 using the LIFO method. The company declared and paid dividends of $480 in 2017. Prepare the retained earnings statement for 2017, assuming that Novak has switched to the FIFO method

Answer 1

1. If comparative income statements are prepared, what net income should Novak report in 2016 and 2017?

Answer:

	2017	2016
Net income	724	788

Calculation

To calculate the net income, if comparative statements are prepared, we need to prepare the statements for 2017 and 2016 using FIFO method. For that we need to take the sales amount from the FIFO details provided and deduct the Cost of goods sold and the operating expenses. Novak’s profit-sharing agreement for employees states company will pay employees 10% of income before profit-sharing. But based on GAAP, Novak has to show the Profit-sharing expense as 86 even though it is 81 based on FIFO method. The income statement prepared for calculating the net income is below:

Novak Company
Income Statement
	2017	2016
Sales	2,910	2,910
Cost of goods sold	1,050	990
Operating expenses	1,050	1,050
Income before profit-sharing	810	870
Profit-sharing expense	86	82
Net income	724	788

2. Assume that Novak has a beginning balance of retained earnings at January 1, 2017, of $738 using the LIFO method. The company declared and paid dividends of $480 in 2017. Prepare the retained earnings statement for 2017, assuming that Novak has switched to the FIFO method?

Answer:

Retained Earnings Statement
Retained earnings, January 1, as reported	738
Cumulative effect of change to FIFO	50
Retained earnings, January 1, as adjusted	788
Add: Net income	724
Deduct: Dividends	(480)
Retained earnings, December 31	1,032

Calculation

Retained earnings, January 1 2017, as reported is provided which is 738. We need to deduct the adjustment for cumulative effect of applying FIFO method.

Cumulative effect of change to FIFO = 31-12-2016 Net Income Determined by FIFO - LIFO = 788 - 738 = 50

Then we need to deduct Cumulative effect of change to FIFO from the Retained earnings, January 1, as reported to get the Retained earnings, January 1, as adjusted.

To that we need to add the Net income for FIFO in 2017 and then deduct the dividends which is provided in the question for 2017 to get the Retained earnings, December 31 2017.