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8 February, 12:34

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 (6,000 units @ $30) $ 180,000 Purchases: 6,000 units @ $36 $ 216,000 6,000 units @ $40 240,000 456,000 Cost of goods available for sale $ 636,000 Sales for 2018 (10,000 units @ $78) $ 780,000 Additional Information: The company's effective income tax rate is 25% for all years. If the company had used the average cost method prior to 2021, ending inventory for 2020 would have been $156,000. 8,000 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?

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Answers (1)
  1. 8 February, 14:44
    0
    retained earnings 60,000 debit

    inventory 60,000 credit

    Inventory 46,000 debit

    COGS 46,000 credit

    The 2021 net income will be higher as COGS are lower now. This is due to the decrease in the inventory valuation which arise from the change in method.

    Explanation:

    We have to calculate the difference in COGS:

    FIFO COGS:

    6,000 units at $36 = 216,000

    4,000 units at $40 = 160,000

    total COGS $376,000

    Average COGS

    6,000 for 156,000 dollars

    6,000 at $40 dollars = 240,000

    396,000 / 12,000 = 33 dollars per unit

    10,000 x 33 = 330,000

    We have to adjust the difference in the beginning inventory and the COGS

    216,000 - 156,000 = 60,000

    As the inventory is lower, previous years COGS should be higher, thus this has an impact on retained earnings.

    Then we adjust cogs for the current year
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