On December 31, 2015, Grantham, Inc. appropriately changed its inventory valuation method to FIFO cost from weighted-average cost for financial statement and income tax purposes. The change will result in a $2,500,000 increase in the beginning inventory at January 1, 2015. Assume a 30% income tax rate. The cumulative effect of this accounting change on beginning retained earnings is
A) $0.
B) $750,000.
C) $1,750,000.
D) $2,500,000.

Question

Quizplus · Accepted Answer

When a company changes its inventory valuation method, it must report the cumulative effect of the change in the current period's income statement as an adjustment to the beginning balance of retained earnings. In this case, the change from weighted-average cost to FIFO cost will increase the beginning inventory by $2,500,000. Since the change is retroactive to January 1, 2015, there will be an adjustment to the beginning balance of retained earnings for the fiscal year ended December 31, 2015.

The cumulative effect of the accounting change on beginning retained earnings is calculated as follows:

Increase in beginning inventory due to change in accounting method = $2,500,000 
Income tax effect (30% income tax rate) = ($750,000)

Therefore, the net increase in beginning retained earnings = $2,500,000 - $750,000 = $1,750,000.

Thus, the correct answer is C.