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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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BuyFindarrow_forward

Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Kraft Manufacturing Company manufactures two products: Mult and Tran. At December 31, 2019, Kraft used the FIFO inventory method. Effective January 1, 2020, Kraft changed to the LIFO inventory method. The cumulative effect of this change is not determinable, and, as a result, the ending inventory of 2019, for which the FIFO method was used, is also the beginning inventory for 2020 for the LIFO method. Any layers added during 2020 should be costed by reference to the first acquisitions of 2020, and any layers liquidated during 2020 should be considered a permanent liquidation.

The following information was available from Kraft’s inventory records for the two most recent years:

Chapter 22, Problem 6P, Kraft Manufacturing Company manufactures two products: Mult and Tran. At December 31, 2019, Kraft

Required:

Compute the effect on income before income taxes for the year ended December 31, 2020, resulting from the change from the FIFO to the LIFO inventory method.

To determine

Ascertain the cumulative effect of the retrospective adjustment, resulting change from the change from the FIFO to LIFO inventory method, on Company KM’s income before income taxes for the year ended December 31, 2020.

Explanation

Accounting changes: When a company requires to sacrifice the consistent accounting methods and procedures, to enhance the usefulness and relevance of the accounting information, those changes are referred to as accounting changes. Such inevitable accounting changes decrease the comparability and consistency of accounting information. The reasons for accounting changes could be new methods introduced by FASB (Financial Accounting Standards Board), changes in accounting principles, and changes in accounting estimates.

The following are the three types of accounting changes:

  • Change in an accounting principle: This change occurs when a company decides to change from an accounting principle to another, like change from LIFO to FIFO. A change in accounting principle effects the values that impact the figures of previous and current years, thus, impairs the consistency and comparability. Hence, the changes in accounting principle should be adjusted with a retrospective effect to impact the previous financial statements, to increase the comparability and the consistency of the values between the previous and current accounting periods.
  • Change in an accounting estimate: This change occurs when a company decides to change the estimates based on the additional information or future events. A change in accounting estimate results out of new experiences and effects the values of current and future period only, but not the previous periods. Hence, the changes in accounting estimates should be accounted for prospectively.
  • Change in a reporting entity: A change in reporting entity occurs due to changes in ownership and operating control due to acquisition. Hence, the changes in reporting entity should be adjusted with a retrospective effect to represent the parent and subsidiary companies as one entity.

Methods of reporting accounting changes:

  • Retrospective adjustment method: This method requires that the previously reported financial statements should be revised to reflect the current accounting change. The change in a reporting entity and change in accounting principle are accounted for retrospectively.
  • Prospective method: This method requires that the current financial statements should be accounted for the changes, and the previously reported financial statements need not be revised. The change in accounting estimate is accounted for prospectively...

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