Question

During 2014 (its first year of operations) and 2015, Batali Foods used the FIFO inventory costing method for both financial reporting and tax purposes. At the beginning of 2016, Batali decided to change to the average method for both financial reporting and tax purposes.

Income components before income tax for 2016, 2015, and 2014 were as follows ($ in millions):

   

	2016			2015			2014
Revenues	$	560		$	530		$	520
Cost of goods sold (FIFO)		(60	)		(54	)		(52	)
Cost of goods sold (average)		(90	)		(84	)		(80	)
Operating expenses		(310	)		(306	)		(298	)

Dividends of $33 million were paid each year. Batali’s fiscal year ends December 31.

   

Required:

1.

Prepare the journal entry at the beginning of 2016 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 2016–2015 comparative income statements. (Enter your answers in millions (i.e., 10,000,000 should be entered as 10).) 3. & 4. Determine the balance in RE at january 2015 as batali reported using FIFO method and adjustment of balance in RE as on january 2015 using average menthod instead of FIFO method. (Enter your answer in millions (i.e., 10,000,000 should be entered as 10).)

Answer 1

1.

	Account Titles	Debit	Credit
	Retained Earnings	58
	Inventory		58

Explanation:

With usage of given values the difference is evaluated as follows:

In $ Millions	2015	2014	Total
Cost of Goods Sold ( FIFO)	54	52
Cost of Goods Sold (Average)	84	80
Difference	30	28	58

As the cost of goods available for each sale period is the sum of the cost of goods sold and the cost of goods unsold (inventory), a $58 million difference ($30 + 28) in cost of goods sold due to using FIFO rather than Average means there also is a $58 million difference in inventory. The cumulative previous year difference in cost of goods sold is impacted as a difference in previous years’ income and hence the balance in retained earnings.

2.

Comparitive Income Statement
	2016	2015
	In Millions ($)
Revenues	560	530
Cost of Goods Sold	(90)	(84)
Operating Expenses	(310)	(306)
Net Income	160	140

3.

Calculations in Millions ($)	2014
Revenues	520
Cost of Goods Sold (FIFO)	(52)
Operating Expenses	(298)
Net Income	170
Dividends	(33)
Retained Earnings Jan 1,2014	0
Retained Earnings Jan 1, 2015	137

4.

2014
	FIFO	Average	Difference
Revenues	520	520
Cost of Goods Sold	(52)	(80)
Operating Expenses	(298)	(298)
Net Income	170	142	28

Comparitive Statement of Share Holder Equity
In Millions ($)	Retained Earnings
Jan,1 2015 **	109
Net Income	137***
Dividends	(33)

** The change in $109 is because of reflection in change of inventory methods.

*** The net income of FIFO is $137 but adjustment of net income to average method is $142. This gives adjusted retained earnings balance as $109($142-$33).