On January 1, 2020, Bluebird Ltd. changed its inventory valuation method from weighted-average cost to FIFO for financial statement and income tax purposes, to make their reporting as reliable and more relevant. The change resulted in a $ 900,000 increase in the beginning inventory at January 1, 2020. Assume a 25% income tax rate. The cumulative effect of this accounting change reported for the year ended December 31, 2020 is
A) $ 0.
B) $ 225,000.
C) $ 675,000.
D) $ 900,000.

Question

Quizplus · Accepted Answer

According to accounting principles, when a company makes a change in its accounting policy, the cumulative effect of the change must be recognized in the financial statements of the period in which the change occurs. Therefore, Bluebird Ltd. must recognize the cumulative effect of this accounting change in the year ended December 31, 2020.

The increase in beginning inventory due to the adoption of FIFO method is $900,000, which means that the company will have a higher cost of goods sold and lower gross profit in the current period. However, this change in inventory valuation method will not have any impact on the company's taxable income as the tax authorities do not allow a change in accounting method for tax purposes.

Therefore, the cumulative effect of this accounting change reported for the year ended December 31, 2020, will be the after-tax impact of the change on the company's net income. The tax rate is 25%, so the after-tax impact will be $675,000 ($900,000 x (1-0.25)).

Hence, the correct answer is C) $675,000.