On December 31, 2015 Dean Company changed its method of accounting for inventory from weighted average cost method to the FIFO method. This change caused the 2015 beginning inventory to increase by $840,000. The cumulative effect of this accounting change to be reported for the year ended 12/31/15, assuming a 40% tax rate, is
A) $840,000.
B) $504,000.
C) $336,000.
D) $0.

Question

Quizplus · Accepted Answer

According to ASC 250-10-45-5, a change in accounting principle (such as a change from weighted average to FIFO) should be accounted for by retrospectively adjusting prior period financial statements. In this case, the 2015 beginning inventory is being retrospectively adjusted, which will result in a cumulative effect adjustment to the beginning balance of retained earnings as of 1/1/15.

The cumulative effect adjustment is calculated as the difference between the beginning balance of retained earnings as of 1/1/15 under the old accounting method and the beginning balance of retained earnings as of 1/1/15 under the new accounting method.

Under the old method, the beginning inventory balance was lower by $840,000. This would have resulted in a higher cost of goods sold and a lower net income for 2015. Therefore, the beginning balance of retained earnings as of 1/1/15 under the old method would have been lower by the amount of the decrease in net income.

The tax effect of the cumulative effect adjustment is calculated by multiplying the adjustment amount by the applicable tax rate. In this case, the tax rate is 40%.

The calculation for the cumulative effect adjustment is as follows: 
Beginning balance of retained earnings as of 1/1/15 under the new accounting method - Beginning balance of retained earnings as of 1/1/15 under the old accounting method 
= -$840,000

Tax effect of cumulative effect adjustment: 
-$840,000 x 40% = -$336,000

Therefore, the cumulative effect adjustment to be reported for the year ended 12/31/15 is $504,000 ($840,000 - $336,000).

On December 31, 2015 Dean Company Changed Its Method of Accounting