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On December 31, 2013, Gifts Galore, Inc
On December 31, 2013, Gifts Galore, Inc. appropriately changed its inventory valuation method from weighted-average cost to FIFO method for financial statement and income tax purposes. The change will result in a $1,800,000 increase in the beginning inventory at January 1, 2013. Assume a 40% income tax rate. The cumulative effect of this accounting change on beginning retained earnings is
a. $0.
b. $1,800,000.
c. $1,080,000.
d. $720,000.
Expert Solution
Option c. $1080000 is correct
This option is correct because
A change in the opening inventory value of the current year affects the closing inventory of the previous year is the opening inventory of the current year. The change in closing inventory affects the profit and the retained earnings are affected by the change in profit.
In the case of gifts galore, the $1800000 increase in the beginning inventory on 1st January 2013 will increase the previous year's net profits by $1080000. The increase in net profits will increase the retained earnings by $1080000.
cumulativeefficiency=Increaseininventory(1−Taxrate)=1800000(1−0.40)=$1080000
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