Question

Millington Materials is a leading supplier of building equipment, building products, materials & timber for sale, with over 200 branches across the Mid-South. On January 1, 2018, management decided to change from the average inventory costing method to the FIFO inventory costing method at each of its outlets.

The following table presents information concerning the change. The income tax rate for all years is 40%.

	Income before Income Tax
	FIFO			Average Cost			Difference
Before 2017	$	25	million	$	18	million	$	7	million
2017		28	million		15	million		13	million
2018		20	million		19	million		1	million

   
Required:
1. Prepare the journal entry to record the change in accounting principle.
2. Determine the net income to be reported in the 2018–2017 comparative income statements.
4. Indicate the affect of the change in the 2018–2017 comparative statements of shareholders’ equity. Cash dividends were $2.80 million each year. Assume no dividends were paid prior to 2017.

Answer 1

Part 1

Inventory (additional amount due to the new method: $7 million + 13 million) = $20 million

Deferred tax liability ($20 million × 40%) = $8 million

Retained earnings is increased by $12 million because the net income in years prior to 2018 would have been higher by that amount.

Entry

Event	general journal	debit	credit
1	inventory	20
	Deferred tax liability		8
	Retained earnings		12

Part 2

	2018	2017
Net income	$16.8 million (28-(28*40%)=	$12 MILLION (20-(20*40%)

PART 4

Statement of shareholders' equity

	Common Stock	additional paid in capital	Retained earnings	total stockholders' equity
Balance at Jan 1 2017			15 (25-(25*40%))
Balance at Dec 31 2017			24.2 (15+12-2.8)
Balance at Dec 31 2018			38.2 (24.2+16.8-2.8)