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Millington Materials is a leading supplier of building equipment, building products, materials, and timber for sale, with over 200 branches across the Mid-South. On January 1, 2024, 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 [tex]$25 \%$[/tex].

\begin{tabular}{lrrr}
& \multicolumn{3}{c}{Income before Income Tax} \\
\cline{2-4}
& FIFO & Average Cost & Difference \\
Before 2023 & \[tex]$25 million & \$[/tex]18 million & \[tex]$7 million \\
2023 & \$[/tex]28 million & \[tex]$15 million & \$[/tex]13 million \\
2024 & \[tex]$20 million & \$[/tex]19 million & \[tex]$1 million \\
\end{tabular}

Required:
1. Prepare the journal entry to record the change in accounting principle.
2. Determine the net income to be reported in the 2024-2023 comparative income statements.
3. Indicate the effect of the change in the 2024-2023 comparative statements of shareholders' equity, assuming cash dividends were \$[/tex]7.00 million each year and that no dividends were paid prior to 2023.



Answer :

GinnyAnswer
Let's address each portion of the problem step by step.

### Part 1: Prepare the journal entry to record the change in accounting principle

To record the change in accounting principle from the average cost to the FIFO method, we need to adjust the retained earnings for the cumulative difference in income before 2023 and 2023.

Cumulative difference:
[tex]\[ \text{Cumulative Difference} = \text{Difference Before 2023} + \text{Difference in 2023}\][/tex]
[tex]\[ \text{Cumulative Difference} = \$7 \text{ million} + \$13 \text{ million} = \$20 \text{ million}\][/tex]

Journal Entry:
[tex]\[ \text{Debit: Inventory} \: \$20 \text{ million}\][/tex]
[tex]\[ \text{Credit: Retained Earnings} \: \$20 \text{ million}\][/tex]

### Part 2: Determine the net income to be reported in the 2024-2023 comparative income statements

Calculation for Net Income in 2023 and 2024 after accounting for the income tax rate of 25%.

#### Net Income for 2023:
[tex]\[ \text{Net Income 2023} = \text{Income before Tax} - (\text{Income before Tax} \times \text{Tax Rate}) \][/tex]
[tex]\[ \text{Net Income 2023} = \$28 \text{ million} - (\$28 \text{ million} \times 0.25) \][/tex]
[tex]\[ \text{Net Income 2023} = \$21 \text{ million} \][/tex]

#### Net Income for 2024:
[tex]\[ \text{Net Income 2024} = \text{Income before Tax} - (\text{Income before Tax} \times \text{Tax Rate}) \][/tex]
[tex]\[ \text{Net Income 2024} = \$20 \text{ million} - (\$20 \text{ million} \times 0.25) \][/tex]
[tex]\[ \text{Net Income 2024} = \$15 \text{ million} \][/tex]

Therefore, the net income to be reported in the 2023 comparative statement is \[tex]$21 million, and for the 2024 comparative statement is \$[/tex]15 million.

### Part 3: Indicate the effect of the change in the 2024-2023 comparative statements of shareholders' equity

Let's calculate the retained earnings for both 2023 and 2024 after accounting for dividends:

#### For 2023:
1. We start with the cumulative difference adjusted for tax:
[tex]\[ \text{Cumulative Difference after Tax} = \text{Cumulative Difference} - (\text{Cumulative Difference} \times \text{Tax Rate}) \][/tex]
[tex]\[ \text{Cumulative Difference after Tax} = \$20 \text{ million} - (\$20 \text{ million} \times 0.25) \][/tex]
[tex]\[ \text{Cumulative Difference after Tax} = \$15 \text{ million} \][/tex]

2. Total retained earnings for 2023:
[tex]\[ \text{Retained Earnings 2023} = \text{Cumulative Difference after Tax} + \text{Net Income 2023} - \text{Dividends 2023} \][/tex]
[tex]\[ \text{Retained Earnings 2023} = \$15 \text{ million} + \$21 \text{ million} - \$7 \text{ million} \][/tex]
[tex]\[ \text{Retained Earnings 2023} = \$29 \text{ million} \][/tex]

#### For 2024:
Total retained earnings for 2024:
[tex]\[ \text{Retained Earnings 2024} = \text{Retained Earnings 2023} + \text{Net Income 2024} - \text{Dividends 2024} \][/tex]
[tex]\[ \text{Retained Earnings 2024} = \$29 \text{ million} + \$15 \text{ million} - \$7 \text{ million} \][/tex]
[tex]\[ \text{Retained Earnings 2024} = \$37 \text{ million} \][/tex]

In summary:

1. The journal entry to record the change in accounting principle is debiting Inventory and crediting Retained Earnings by \[tex]$20 million. 2. The net income to be reported in the 2023 comparative statement is \$[/tex]21 million, and in the 2024 comparative statement is \[tex]$15 million. 3. The retained earnings should be \$[/tex]29 million for 2023 and \$37 million for 2024 after accounting for dividends in the shareholders' equity statements.