 Hello and welcome to this session. This is Professor Farhad in which we would look at an example that deals with changes in accounting principle. This example could be considered a CPA simulation or could be just a regular exercise in your intermediate accounting course. Regardless, you need to know how to deal with changes in accounting principle. Let's go ahead and get started. Adam began operation in year 20x1 and for simplicity the company started using the weighted average to account for its inventory. At the beginning of year 20x3 they changed their inventory method to FIFO in accordance with the company with other companies in the industry. And here we have the pre-tax income under both method the weighted average what they used to use in FIFO and assume a tax rate of 20%. So we're going to try to answer three questions and when I'm as I'm answering those questions I will also explain the changes in accounting principle. However, just bear in mind this is an example. I did explain this topic in the previous session so see the previous session if you want more detailed explanation. So we're going to compute what's income for 20x3 or specifically net income and we're going to compute the cumulative effect of the change in accounting principle then we're going to show competitive net income for x1, x2 and x3 under FIFO. Let's start with the first question. What is net income for 20x3? Well 20x3 is right here and 20x3 we are using FIFO. Well the income before taxes is half a million. Guess what? We're going to have to pay taxes of 20% so if we pay taxes of 20% that's 100,000 so net income will be 400,000. Net income will be 400,000 or what we can do another way to do it is we can take half a million times 0.8 which is 1-d tax rate which will give you the same answer of 400,000 so that's the answer for the first question. Again this could be a simulation where you have to input this answer in a box. Now before we proceed any further and answer the other two questions most likely you are a student or a CPA candidate if you're watching. If that's the case welcome you have arrived you are looking for some help go a step further go to farhatlectures.com where you will find additional resources, lectures, multiple choice, true false exercises that's going to help you whether you are taking an accounting course or studying for your CPA exam. Connect with me on social media, LinkedIn, YouTube, Twitter, Reddit, Instagram and Facebook. Let's answer the question number two compute the cumulative effect of the change in accounting principle. Now how do we compute the cumulative effect? What we are assuming here just basically based on the question is we are only showing 20x3 20x3 okay and by the way by the way I just want to go back to the first question. I want you to be aware that changes in accounting principle does not affect net income so that's the other thing that's the purpose of the question what's net income for 20x3 the change from FIFO to LIFO does not affect net income so now we're going to compute the change and show its effect so what do we need to do we are going to find the difference between income before taxes the weighted average versus FIFO so income under FIFO the do method will increase our income by 15,000 the for 20x2 income under FIFO would have been an increase of 15 overall it's an increase of 45,000 therefore the first thing I have to do I have to increase my inventory adjust my inventory because my inventory will have to be increased and as a result I have more profit why because as my inventory goes up my cost of goods sold it's being you know it's being reduced but it's from prior year I cannot reduce cost of goods sold but reducing cost of goods sold would have increased my profit an increase in my profit would have increased my retained earnings now I don't increase my retained earnings by 45,000 because I have a liability a tax liability associated with that what's my tax liability well if I'm putting back 45,000 it means reducing my expenses by 45,000 increasing my profit I have to account for a 9,000 as the tax rate is 20% as the third tax liability so that's the journal entry and this is basically what we do is we input this journal entry at the beginning of 2020 x3 and this 36,000 is is the is the adjustment to the beginning retained earnings therefore what's going to happen we would increase retained earnings and I show you in the recording how it's presented by 36,000 as a prior period adjustment due to changes in accounting principle and we move on with our life assuming we are only showing 20x3 and we're not showing the prior years now we are being asked what would you do if you are showing competitive net income for 20x1, 20x2 and 20x3 under the new method FIFO well under those circumstances you have a little bit more work to do why because you have to go back and show income s395, 430 and half a million you have to go back and retrospectively adjust your financial statements so all three years are competitive you cannot you cannot keep 20x3 as FIFO and using weighted average for the other two you can't do that you have to use FIFO for everything this is the purpose of the question so the purpose of the question is to remind you if you are using if you are showing comparative multiple year you have to go back and make the changes and often time that's not really easy for the company especially when it comes to inventory but this is a good illustration of changes in accounting principle what should you do now go to farhatlectures.com work multiple choice through false exercises that's going to help you understand this important concept better good luck study hard stay safe and don't short change yourself