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During 2022 (its first year of operations) and 2023, Fleri Foods used the FIFO inventory costing method for both financial reporting and tax purposes. At the beginning of 2024, Fleri decided to change to the average method for both financial reporting and tax purposes.

Income components before income tax for 2022, 2023, and 2024 were as follows:

\begin{tabular}{llll}
(\[tex]$ in millions) & 2022 & 2023 & 2024 \\
Revenues & $[/tex]\[tex]$ 480$[/tex] & [tex]$\$[/tex] 490[tex]$ & $[/tex]\[tex]$ 520$[/tex] \\
Cost of goods sold (FIFO) & [tex]$(48)$[/tex] & [tex]$(50)$[/tex] & [tex]$(56)$[/tex] \\
Cost of goods sold (average) & [tex]$(72)$[/tex] & [tex]$(76)$[/tex] & [tex]$(82)$[/tex] \\
Operating expenses & [tex]$(282)$[/tex] & [tex]$(290)$[/tex] & [tex]$(294)$[/tex]
\end{tabular}

Dividends of [tex]$\$[/tex] 29$ million were paid each year. Fleri's fiscal year ends December 31.

Required:
1. Prepare the journal entry at the beginning of 2024 to record the change in accounting principle. (Ignore income taxes.)
2. Prepare the 2024-2023 comparative income statements.
3. Determine the balance in retained earnings at January 1, 2023, as Fleri reported using FIFO method.
4. Determine the adjustment of balance in retained earnings as of January 1, 2023, using the average method instead of the FIFO method.



Answer :

GinnyAnswer
Sure, let's tackle this problem step-by-step. We need to adjust the inventory costing method from FIFO to the average method and see how this affects Fleri Foods' retained earnings and income statements.

### 1. Journal Entry at the Beginning of 2024 to Record the Change in Accounting Principle
At the beginning of 2024, we need to record the effect of the change in accounting principle on retained earnings.

Journal Entry:

1. Calculate the cumulative effect of the change on retained earnings for 2022 and 2023:

Cost of Goods Sold (FIFO):
- 2022: [tex]\((48) \text{ million}\)[/tex]
- 2023: [tex]\((50) \text{ million}\)[/tex]

Cost of Goods Sold (Average):
- 2022: [tex]\((72) \text{ million}\)[/tex]
- 2023: [tex]\((76) \text{ million}\)[/tex]

Difference in Cost of Goods Sold:
- 2022: [tex]\((72 - 48) = 24 \text{ million}\)[/tex]
- 2023: [tex]\((76 - 50) = 26 \text{ million}\)[/tex]

Cumulative Effect on Retained Earnings:
- [tex]\((24 + 26) = 50 \text{ million}\)[/tex]

Journal Entry:

[tex]\[ \begin{align*} \text{Retained Earnings} & \quad \text{Debit} \quad 50 \text{ million}\\ \text{Inventory} & \quad \text{Credit} \quad 50 \text{ million} \end{align*} \][/tex]

This entry records the cumulative increase in cost of goods sold under the average method, which decreases retained earnings.

### 2. Comparative Income Statements for 2024 and 2023

We need to adjust the income statements to reflect the average costing method:

[tex]\[ \begin{tabular}{lrr} \hline (\$ in millions) & 2023 (Average) & 2024 (Average) \\ \hline Revenues & 490 & 520 \\ Cost of Goods Sold (Average) & (76) & (82) \\ Gross Profit & 414 & 438 \\ Operating Expenses & (290) & (294) \\ Operating Income & 124 & 144 \\ \hline \end{tabular} \][/tex]

### 3. Determination of Retained Earnings at January 1, 2023, Using FIFO Method

First, let's calculate the retained earnings at the beginning of 2023 using FIFO:

Income for 2022:
- Revenues: 480 million
- Cost of Goods Sold (FIFO): [tex]\(48 \text{ million}\)[/tex]
- Operating Expenses: [tex]\( (282) \text{ million}\)[/tex]
- Net Income for 2022: [tex]\(480 - 48 - 282 = 150 \text{ million}\)[/tex]
- Dividends: [tex]\(29 \text{ million}\)[/tex]
- Retained Earnings for 2022: [tex]\( 150 - 29 = 121 \text{ million}\)[/tex]

Retained Earnings for 2023:
- Assume beginning retained earnings: [tex]\(\text{R.E.}_{2022} = 121 \text{ million} \)[/tex]
- Net Income for 2023 (FIFO-based): [tex]\((490 - 50 - 290 = 150 \text{ million})\)[/tex]
- Dividends: [tex]\(29 \text{ million}\)[/tex]
- Retained Earnings: [tex]\(121 + 150 - 29 = 242 \text{ million}\)[/tex]

### 4. Adjustment of Balance in Retained Earnings on January 1, 2023, Using Average Method

Now adjust the retained earnings for the impact of switching to the average method:

Cumulative Impact (as calculated above):

[tex]\(24 \text{ million} (for 2022) + 26 \text{ million} (for 2023)\)[/tex]

Average Method Retained Earnings:

- Retained Earnings for 2023: FIFO-based [tex]\(242 \text{ million}\)[/tex]
- Less Cumulative Adjustment: [tex]\(50 \text{ million}\)[/tex]
- Retained Earnings: [tex]\(242 - 50 = 192 \text{ million}\)[/tex]

### Summary:
- Prepare the journal entry for the change in accounting principle.
- Adjust the comparative income statements for 2023 and 2024.
- Determine FIFO-based retained earnings at the beginning of 2023.
- Adjust retained earnings for the average costing method.

Note: Taxes are ignored as per the problem's instructions.