Question

Goddard Company has used the FIFO method of inventory valuation since it began operations in 2015. Goddard decided to change to the average cost method for determining inventory costs at the beginning of 2018. The following schedule shows year-end inventory balances under the FIFO and average cost methods:

Year	FIFO			Average Cost
2015	$	47,000		$	58,000
2016		84,000			73,000
2017		91,000			84,000

Required:
1. Ignoring income taxes, prepare the 2018 journal entry to adjust the accounts to reflect the average cost method.
2. How much higher or lower would cost of goods sold be in the 2017 revised income statement?

Answer 1

Ans:

Date	Account Title & Explanation	Debit	Credit
2018	Retained Earnings	$7,000
	Inventory		$7,000
	(Entry to Record Adjustment to reflect Average cost Method)
	Particulars	Amount
2	Decrease in Beginning inventory	($11,000)
	(84,000 - 73,000)
	Add: Decrease in Ending inventory	$7,000
	(91,000-84,000)
	Net change in the cost of goods sold	($4,000)
	The cost of goods sold in the year 2017 will decrease by $4,000.

Expanation:

1) Cost of goods sold is = Beginning inventory + purchases during the period - Ending inventory.

2) The higher the value of Beginning inventory, the higher will be the cost of goods sold and vice versa. On the contrary, higher the value of the Ending inventory, lower will be the cost of goods and vice versa.

3) In the given case, the cost of goods sold in the year 2017 will have effect of both the beginning inventory (that is, the Ending inventory of year 2016) and the Ending inventory of the year 2017 as the value of both the inventories have changed due to change in the method.