Question

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 (5,500 units @ $27)				$	148,500
Purchases:
5,500 units @ $33	$	181,500
5,500 units @ $37		203,500			385,000
Cost of goods available for sale				$	533,500
Sales for 2018 (8,000 units @ $75)				$	600,000

Additional Information:

1. The company's effective income tax rate is 25% for all years.
2. If the company had used the average cost method prior to 2021, ending inventory for 2020 would have been $126,500.
3. 8,500 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.

• Record adjustment to reflect average cost method.

Note: Enter debits before credits.

	Transaction General Journal Debit Credit

2. What is the effect of the change in methods on 2021 net income?

	The effect of the change for the year 2021 is a decrease OR increase in cost of goods sold resulting in a    decrease OR increase   in income before taxes and a(n) decrease OR increase in income after tax. - -

Answer 1

1)

Decrease in opening inventory decreases the cost of goods sold (148500-126500)	22000
Current purchases	385000
Total cost	407000
Total no of units	16500
Weighted average price	24.66667
Cost of goods sold (5500) Fifo Method	148500
Second lot 2500 units @ $ 33	82500
Total cost of goods sold under Fifo	231000
Cost of goods sold under weighted average 8000*24.666	197333.3
Cost of goods sold decreases hence profit increases	33666.67
Total reduction of cost of goods sold is 22000+33666.67	55666.67

Journal entry- The decrease in cost of goods sold results in increase in closing stock hence the same will be reflected there.

A. Closing stock A/c Debit 55,667

To Profit due to change in inventory valuation method A/c Credit 55,667

B. Profit due to change in inventory valuation method A/c Debit 55,667

To profit and loss A/c credit 55,667

2) The tax is 55,667*25% =13916.67

Net income post tax is 41750

As a result of change in inventory valuation the tax amount increases, the closing stock increases and income for the period also increases to the extent of 41750 post tax.