Masango Materials is a leading supplier of building equipment, building products, materials, and timber for sale, with over 300 locations across the Mid-Atlantic. On January 1, 2027, management decided to change from the average inventory costing method t

To address the requirements of the question regarding Masango Materials' change from the average inventory costing method to FIFO, we will go through each point step by step. ### 1. Prepare the journal entry to record the change in accounting principle. The change in accounting principle requires retrospective application of the change. The difference in equity needs to be recorded through retained earnings. This involves adjusting the retained earnings for prior periods as if FIFO had always been used. - **Journal Entry:** ```plaintext Retained Earnings (Prior Period Adjustment) 14 million Inventory 14 million ``` This entry reflects the adjustment made to retained earnings for the previous years where FIFO would have resulted in higher reported earnings compared to the average cost method (before 2026). ### 2. Determine the net income to be reported in the 2027–2026 comparative income statements. All years must be restated to reflect FIFO. We'll need to consider the income before income tax with the tax effect taken into account. **Net Income Calculation:** **2026:** - Income before Income Tax (FIFO): $16 million - Less: Income tax (25%): $4 million - **Net Income (FIFO):** $16 million - $4 million = $12 million **2027:** - Income before Income Tax (FIFO): $20 million - Less: Income tax (25%): $5 million - **Net Income (FIFO):** $20 million - $5 million = $15 million ### Comparative Income Statements **For 2026:** - FIFO Net Income: $12 million - Average Cost Net Income: $10 million **For 2027:** - FIFO Net Income: $15 million - Average Cost Net Income: $18 million ### 3. Indicate the effect of the change in the 2027–2026 comparative statements of shareholders’ equity assuming cash dividends were $2 million each year. **Statement of Shareholders’ Equity:** - For 2026: - Retained Earnings (beginning): TBD - Add: Net Income (FIFO): $12 million - Less: Cash dividends: $2 million - **Ending Retained Earnings (FIFO for 2026):** TBD + $12 million - $2 million - For 2027: - Retained Earnings (beginning): Ending Retained Earnings from 2026 - Add: Net Income (FIFO): $15 million - Less: Cash dividends: $2 million - **Ending Retained Earnings (FIFO for 2027):** Ending Retained Earnings from 2026 + $15 million - $2 million ### Summary of the effects on Shareholders' Equity: - **Ending Retained Earnings for 2026** (with FIFO) would increase due to the increased net income ($12 million vs. $10 million). Specific values depend on the initial retained earnings. - **Ending Retained Earnings for 2027** would also reflect the increase to $15 million net income compared to $18 million under average cost, thus increasing shareholders' equity further. Thus, the overall effect of the change in accounting principle would lead to higher reported retained earnings for both years due to the use of FIFO yielding higher income, which will affect total shareholders’ equity positively. This analysis shows how accounting changes can impact financial statements and equity figures, reflecting changes in the underlying inventory valuation methodology.