In year 2, Reynolds changes its inventory method from FIFO to the weighted-average method. If the weighted-average method would have been used in year 1, cost of goods sold would be $10,000 higher. Reynolds has an effective tax rate of 40%. What is the after-tax effect on retained earnings for year 1 for the change in accounting method

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Sarah Browning

Business

17 February, 12:29

In year 2, Reynolds changes its inventory method from FIFO to the weighted-average method. If the weighted-average method would have been used in year 1, cost of goods sold would be $10,000 higher. Reynolds has an effective tax rate of 40%. What is the after-tax effect on retained earnings for year 1 for the change in accounting method

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Holly Hanson · Answer 1

Retained earnings for year 1 would be lower by $6000

Explanation:

A change in inventory valuation method resulted in higher cost of goods sold for the previous year.

This means had the new method of inventory valuation i. e weighted average been followed, the gross profit would have been lower by $10,000.

Had gross profits been lower by $10,000, it would've led to net income being lower by $10,000. After deduction of 40% tax rate on such income, the after tax income would've been $6000 lower.

This further means the balance of retained earnings would've been reduced by $6000.