Question

Pharoah Incorporated decided to change from the FIFO method to value Inventory to the weighted average method In July 2017. The cumulative effect on prior years of retrospective application of the new Inventory costing method was determined to be $21,500 net of $7,000 tax. As prices are decreasing, cost of sales would be lower and ending inventory higher for the preceding period. Retained earnings on January 1. 2017 was $243,500 . (a1) Prepare a partial statement of retained earnings illustrating the adjusted balance af retained earnings. Statement of Retained Earnings (Partial)

Answer 1

• All working forms part of the answer
• Method has been changed from FIFO to Weighted Average and it states that prices were decreasing. Hence, ending inventory as per FIFO would have been at lower prices. When it will be valued at Weighted Average method, the inventory balance will increase.
• Increase in Inventory balance will lead to higher gross profits, higher net income and then higher Retained earnings.
• Hence, retained earnings will be credited by the amount of increase (net of tax)
• The journal entry for the adjustment will be:

Account title & Explanation	Debit	Credit
Inventory	$                                   28,500.00
Income tax payable		$                    7,000.00
Retained earnings		$                  21,500.00
(adjusting entry for change in accounting policy)

• After the above entry, the Statement of Retained Earnings will be disclosed as follows:

Statement of Retained earnings (PARTIAL)
Beginning Balance	$                                 243,500.00
Prior Period adjustments:
Adjustment of Inventory	$                                   28,500.00
Adjustment of Income taxes payable	$                                   (7,000.00)
Balance after affecting changes	$                                 265,000.00