CHAPTER 20 Accounting Changes and Error Corrections 1199 tion Mayfair D epartmen
ID: 2524301 • Letter: C
Question
CHAPTER 20 Accounting Changes and Error Corrections 1199 tion Mayfair D epartment Stores operates over 30 retail stores in the Pacific Northwest. Prior to 2018, the company used the FlFO method to value its inventory. In 2018, Mayfair decided to switch to the dollar-value LIFO retail invent ory method. One of your responsibilities as assistant controller is to prepare the disclosure note describing ethod; ote the change in method that will be included in the company's 2018 financial statements. Kenneth Meier, the con- Internally developed retail price indexes are used to adjust for the effects of changing prices. If the change had not been made, cost of goods sold for the year would have been $22 million lower. The com- pany's income tax rate is 40% and there were 100 million shares of common stock outstanding during 2018. The cumulative effect of the change on prior years' income is not determinable The reasons for the change were (a) to provide a more consistent matching of merchandise costs with sales revenue, and (b) the new method provides a more comparable basis of accounting with competitors that also use the LIFO method. Required: 1. Prepare for Kenneth Meier the disclosure note that will be included in the 2018 financial statements. 2. Explain why the "cumulative effect of the change on prior years' income is not determinable."Explanation / Answer
There is a change in the inventory method from FIFO to LIFO.
1. Disclosure
The disclosure note to be prepared for Kenneth Meier that will be included in the 2018 financial statement is as follows:
The Company has changed the inventory valuation method from First-In, First-Out (FIFO) to Last-In, First-Out (LIFO) determined by the retail method.
The company utilizes internally developed price indices to estimate the effects of changing retail prices on inventories.
The effect of the change in the inventory valuation method is reduction of the net income of 2018 by $13.2 million and earnings per share (EPS) is reduced by $0.13. The retrospective effect of change in the inventory valuation method is impracticable since the cumulative effect of the change in prior years was not determinable.
The Company believes that such would provide reliable merchandise cost matching with the sales revenue and would prove to be the best method for accounting comparison with the competitors.
Note: if the change would not have been effected, the cost of goods sold would have been lower by $22 million and thus the income before tax, would have been higher by $22 million and net income would have been higher by $13.2 million with the 40% tax rate applicable to the company.
2. The “cumulative effect of the change in prior years” income is not determinable because it is very difficult to ascertain appropriate LIFO inventory layers, which is necessary to recognize prior to year of the change. So it is virtually impracticable to calculate the cumulative effect on a change to LIFO.
Therefore, the change to LIFO method could not be made with retrospective effect.