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 ($ in millions): 2018 2017 2016 Revenues $ 550 $ 520 $ 510 Cost of goods sold (FIFO) (59 ) (53 ) (51 ) Cost of goods sold (average) (88 ) (82 ) (78 ) Operating expenses (306 ) (302 ) (294 ) Dividends of $32 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.

__1__Prepare the journal entry at the beginning of 2018 to record the change in accounting principle. (Ignore income taxes.) (If no entry is required for a transaction/event, select "No journal entry required" in the first account field. Enter your answers in millions (i.e., 10,000,000 should be entered as 10).)

__2__Prepare the 2018–2017 comparative income statements. (Enter your answers in millions (i.e., 10,000,000 should be entered as 10).)

__3__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. (Enter your answers in millions (i.e., 10,000,000 should be entered as 10).)

Answer 1

	2017	2016
Cost of goods sold (FIFO)	53	51
Cost of goods sold (average)	82	78
Difference	29	27

The cost of goods as per the average inventory method is higher compared to the FIFO method of valuation. Reporting the higher cost of goods sold i.e expenses reduces the profit and thereby impacts retained earnings.

Journal entry for cumulative difference (29 +27) is as below :

Retained Earnings Dr...      56

To Inventory                                56

2.

	2018	2017
Revenues	550	520
Less: Cost of goods sold (average)	88	82
Less: Operating Expenses	306	302
Net Income	156	136

3.

At the beginning of Jan 2017
Revenues	510
Less: Cost of goods sold (FIFO)	51
Less: Operating Expenses	294
Net Income	165
Less : Dividend Paid	32
Retained Earnings	133

4.

At the beginning of Jan 2017
	FIFO	Average
Revenues	510	510
Less: Cost of goods sold	51	78
Less: Operating Expenses	294	294
Net Income	165	138
Less : Dividend Paid	32	32
Retained Earnings	133	106