 Hello and welcome to the session. This is Professor Farhad in which we would look at a CPA simulation or an exercise from an intermediate accounting course that deals with changes in accounting principle. This topic gives students difficult time, whether it's in your intermediate accounting class or in your on the CPA exam. And the reason is simple, because when it comes to changes in accounting principle, you have to recall and apply certain basic concepts that you learn early on in your accounting education. If you never learn them properly or if you forgot about them, you may not be able to apply those changes in accounting principle. Before we start, I would like to always remind you to connect with me only then. If you haven't done so, please subscribe to my YouTube where I'm getting closer to two thousand videos of accounting, finance, tax, audit, as well as Excel tutorials. If you like my lectures, please like them and share them. You know, if they benefit you, it means they might benefit other people. Share the wealth. If you are interested in learning more, please visit our website for health lectures.com. You will find additional resources, whether you are studying for your CPA exam or you are taking accounting courses, supplemental material that's going to help you with your education. I strongly suggest you check it out. Let's go ahead and start toward this problem. Robinson Corporation decided to switch from LIFO method to FIFO beginning of 2021. The inventory as reported at the end of the 2020 using LIFO would have been 62000 percent higher using FIFO. So when we switch, what happened? Our ending inventory, our ending inventory went up by how much? By exactly 62,000 of the other result as a result. The retained earnings at the end of the 2020 was reported as 800,000. That's reflecting LIFO. The tax rate is 35%. The first thing they want us to do is to compute the balance and retained earning at the time of the change, which is what is your retained earning at the beginning of 2021? It cannot be 800,000. It's going to change. Now here where students are challenged or they're not really sure how to deal with this. Well, you have to understand the relationship between ending inventory and retained earnings. Well, what's the relationship between ending inventory and retained earnings? Well, it's going to go through one or two intermediate steps. First, you have to understand the relationship between ending inventory and cost of goods sold. Well, what happened is this? Your inventory, ending inventory went up as a result. What's going to happen is there's an inverse relation relationship as a result. Your cost of goods sold will go down. If your cost of goods sold go down by 62,000, if that's the result of the change, what does that mean for net income? It means net income would have went up. Net income would be up by how much? 62,000. And what happened if your net income is up? Well, your retained earnings will always be up by 62,000. So this is the general idea. So you need to understand the basic concept that you learned in financial accounting. In your basic course, the relationship between ending inventory and cost of goods sold, they're inversely related. Once you know that, you know the effect on retained earning will be positive. However, you still have to account for taxes, which we'll see in a moment. So let's see how we would solve this problem. So this could be, you know, again, a CPA simulation. What is your beginning of retained earning using LIFO? LIFO is the old method. It's 800,000. Then what you do is you add to it. You add to the 800,000, 62,000. Why? Because the result of this change lowered your cumulative cost of goods sold, which made your cumulative net income higher. However, if you are going to be increasing your income by 62,000, remember you have to pay Uncle Sam once Durbil, which is 35%. You're going to be responsible for 21,700 in taxes. What does that mean? It means you have to lower your income less 21,700 in taxes. This means the net change, the net cumulative and net income and retained earning increase is 40,300. So this is the net increase. So remember to take into account the tax change. Now, what happened to your beginning retained earning? Your beginning retained earning is of January 1st. Using the new method LIFO is 840,300. Now, obviously, what the company will have to do, they will have to disclose this information in the notes of the financial statements. So users will understand what actually happened. And they would say, at the beginning of 2021, we switched from LIFO to LIFO as a result. Our cost of goods sold went down. Our net income went up. We have additional taxes to pay. And basically, now you have this number to start with going forward. Now also, we have to prepare a journal entry. And what's the journal entry? We have to increase inventory by 62,000. That's obvious. We have to increase retained earning by 40,300, which is the net change. And now we are responsible for paying taxes of 21,700. Therefore, the entry will balance. So this is the retain... You might be asked to prepare the new retained earnings or the journal entry or both. I wouldn't be surprised if you see this in the CPA simulation or you might see this in a multiple choice and they might ask you how much additional taxes you are responsible for. What's the ending retained earning? What's the net change in retained earnings? You can ask you so many different questions about the scenario like this. As always, before I end, I would like to remind you that if you are studying for your CPA exam, this is a lifetime investment. 20 to 30, if not 40 years, people are living longer. 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