CHAPTER 8 CHANGE IN ACCOUNTING POLICY Problem 8-1 (AICPA Adapted) During 2018, Orca Company decided to change from the FIFO inventory valuation to the weighted average method. The income tax rate is 30%, FIFO Weighted average January | inventory 7,100,000 7,700,000 December 31 inventory 7,900,000 8,200,000 What amount should be reported as the cumulative effect of this accounting change for 2018? a. 420,000 increase b. 420,000 increase c. 600,000 increase d. 600,000 decrease Solution 8-1 Answer a FIFO inventory - January | 7,100,000 Weighted average inventory - January | 7,700,000 Cumulative effect ‘ 600,000 Cumulative effect after tax (70% x 600,000) 420,000 The change from FIFO to weighted average is a change in accounting policy. The cumulative effect of the change accounting policy is an adjustment of retained earnings. Inventory 600,000 Retained earnings : 420,000 Increase tax payable 180,000Problem 8-2 (AICPA Adapted) 7 jy P f invento: Goddard Company had used the FIFO method 0 entory val uation since t began operations in 2015. The entity decided to change to the weighted average method for measuring inventory at the beginning of 2018. The income tax rate is 30%. The following schedule shows year-end inventory b: FIFO Weighted average lances: Year 2015 4,500,000 5,400,000 2016 7,800,000 7,100,000 20li 2. 8,300,000 7,800,000 What amount should be reported for 2018 as the cumulative effect of the change in accounting policy? a. ~ 500,000 decrease b. 350,000 decrease c. 500,000 increase d. 350,000 increase Solution 8-2 Answer b Inventory, December 31, 2017 FIFO 8,300,000 Weighted average 7,800,000 Decrease in inventory 500,000 The adjustment on January 1, 2018 to reflect the change in inventory method is: Retained earnings (70% x 500,000) 350,000 Income tax payable (30% x 500,000) 150,000 Inventory : 500,000 Since the retained earnings account is a debit, it is shown as a deduction. Note that the cumulative effect of a change in i thod is determined by considering only the ending it reeay econ preceding year which in this case is 2017. oe The inventory balances in 2015 and 2 : . effect on net income is counterbalan cing. are ignored because theProblem 8-3 (IAA) Banko Company used the cost recovery method of accounting since it began operations in 2015. In 2018, management decided to adopt the percentage of completion method. 2015 2016 2017 Revenue from completed contracts 25,000,000 42,000,000 40,000,000 Cost of completed contracts 18,000,000 _ 29,000,000 _ 28,000,000 Income from operations 7,000,000 13,000,000 12,000,000 Casualty loss 0 0 (2,000,000) Income 000,000 10,000,000 Analysis of the accounting records disclosed the following income by contracts using the percentage of completion method. 2015 2016 2017 Contract | 7,000,000 Contract 2 5,000,000 8,000,000 Contract 3 3,000,000 7,000,000 2,000,000 Contract 4 1,000,000 6,000,000 Contract 5 (1,000,000) Before income tax, what is the cumulative effect of change in accounting policy that should be reported in the statement of retained earnings for 2018? a. 6,000,000 b. 8,000,000 c. 7,000,000 d. 0 Solution 8-3 Answer a — (38,000,000-32,000,000) 6,000,000 Percentage of completion Cost recovery method 2015 15,000,000 7,000,000 2016 16,000,000 13,000,000 2017 7,000,000 12,000,000 Total 38,000,000 32,000,000Problem 8-4 (IAA) During 2018, Build Company changed from the cost recovery method to the percentage of completion method. The tax rate is 30%. Gross profit figures are: 2016 2017 2018 Cost recovery method 950,000 1,250,000 1,400,000 Percentage of completion 1,600,000 1,900,000 2,100,000 How should this accounting change be reported in 2018? a. 1,400,000 increase in profit or loss b. 1,400,000 increase in retained earnings c. 910,000 increase in profit or loss d. 910,000 increase in retained earnings Solution 8-4 Answer d Cumulative gross profit for 2016 and 2017 — percentage of completion 3,500,000 Cumulative gross profit for 2016 and 2017 — cost recovery (2,200,000) Cumulative increase 1,300,000 Tax effect (1,300,000 x 30%) (390,000) Addition to retained earnings on January 1, 2018 910,000 Problem 8-5 (AICPA Adapted) During 2018, Foster Company appropriately changed to the FIFO method from the weighted average method for financial statement and income tax purposes. The change will result in P2,000,000 increase in the beginning inventory on January 1,2018. The tax rate is 30%. What is the prior period specific effect of this accounting change? a. 2,000,000 b. 1,400,000 c. 600,000 a. 0 Solution 8-5 Answer b Journal entry on January 1, 2018 Inventory y : 2,000,000 Retained earnings (2,000,000x 70%) 1,400,000 Income tax payable (2,000,000 x 30%) ‘600,000Problem 8-6 (AICPA Adapted) ABC Company provided the following net income and inventory: 2018 2019 Net income using LIFO 2,750,000 3,000,000 Year-end inventory - FIFO 1,400,000 2,000,000 Year-end inventory - LIFO 900,000 1,600,000 What is the net income for 2019 using the FIFO cost flow? 2,900,000 2,600,000 3,500,000 3,100,000 aoge Solution 8-6 Answer a 2018 2019 Net income - LIFO 2,750,000 3,000,000 Understatement inventory Z 2018 (1,400,009 - 900,000) 500,000 ( 500,060) 2019 (2,009,000 - 1,600,000) - 400,000 Net income - FIFO 3,250,000 2,900,000