Question

Rockwell Corporation uses a periodic inventory system and has used the FIFO cost method since inception of the company in 1979. In 2021, the company decided to switch to the average cost method. Data for 2021 are as follows:

Beginning inventory, FIFO (6,900 units @ $25)				$	172,500
Purchases:
6,900 units @ $31	$	213,900
6,900 units @ $35		241,500			455,400
Cost of goods available for sale				$	627,900
Sales for 2018 (8,000 units @ $60)				$	480,000

Additional Information:

1. The company's effective income tax rate is 25% for all years.
2. If the company had used the average cost method prior to 2021, ending inventory for 2020 would have been $144,900.
3. 12,700 units remained in inventory at the end of 2021.

Required:
1. Ignoring income taxes, prepare the 2021 journal entry to adjust the accounts to reflect the average cost method.
2. What is the effect of the change in methods on 2021 net income?

Answer 1

1)

Change in method of inventory valuation is a change in accounting policy. When an accounting policy is changed retrospective effect should be given the effect of the change in the current financial year by adjusting retained earnings.

Here Rockwell corporation changing inventory valuation method from FIFO to weighted average. The effect of change in valuation is adjusted to opening retained earnings.

Retained earnings (172500-144900)	$       27,600
Inventory		$       27,600
(Adjustment for change in method of inventory valuation)

2)

Cost of goods sold as per existing FIFO
As per FIFO, first 8000 units consumed are used for cost of goods calculation
Units sold	Cost per unit	Cost of goods sold
6,900	$               25	$   1,72,500
1,100	$               31	$       34,100
		$   2,06,600

Cost of goods sold as per average cost method (perodic inventory)
Units sold	Cost per unit	Total cost
6,900		$   1,44,900
6,900	$               31	$   2,13,900
6,900	$               35	$   2,41,500
20,700		$   6,00,300
Average cost per unit (600300/20700)		$               29
Units sold		8,000
Cost of goods sold (8000*29)		$   2,32,000

Cost of goods sold as per existing FIFO			$ 2,06,600
Cost of goods sold as per weighted average cost			$ 2,32,000
Net Income decrease by in 2021			$   -25,400