Question

Presented below are income statements prepared on a LIFO and FIFO basis for Kenseth Company, which started operations on January 1, 2016. The company presently uses the LIFO method of pricing its inventory and has decided to switch to the FIFO method in 2017. The FIFO income statement is computed in accordance with the requirements of GAAP. Kenseth’s profit-sharing agreement with its employees indicates that the company will pay employees 10% of income before profit-sharing. Income taxes are ignored. LIFO Basis FIFO Basis 2017 2016 2017 2016 Sales \(3,000 \)3,000 \(3,000 \)3,000 Cost of goods sold 1,130 1,000 1,100 940 Operating expenses 1,000 1,000 1,000 1,000 Income before profi t-sharing 870 1,000 900 1,060 Profi t-sharing expense 87 100 96 100 Net income \( 783 \) 900 \( 804 \) 960 Instructions Answer the following questions. (a) If comparative income statements are prepared, what net income should Kenseth report in 2016 and 2017? (b) Explain why, under the FIFO basis, Kenseth reports \(100 in 2016 and \)96 in 2017 for its profit-sharing expense. (c) Assume that Kenseth has a beginning balance of retained earnings at January 1, 2017, of \(900 using the LIFO method. The company declared and paid dividends of \)500 in 2017. Prepare the -retained earnings statement for 2017, assuming that Kenseth has switched to the FIFO method.

Short answer

The net income of 2017 is $804, 2016 is $960, and closing retained earnings is $1,264. The amounts are recorded as $96 and $100 because of the indirect effect.

Step-by-step solution

Comparative Income Statement

	2017 ($)	2016 ($)
Sales	3,000	3,000
Cost of goods sold	1,100	940
Operating expenses	1,000	1,000
Income before profit sharing	900	1,060
Profit-sharing Expenses	96	100
Net Income	804	960

Explanation of the amounts

This is the indirect effect, as this happened in the period before the change. The profit-sharing expenses were recorded as $96 and $100 in 2017.

Retained Earnings Statement

	2017 ($)
Retained earnings, Jan 1 as reported	900
Cumulative Effect change to FIFO	60
Retained Earnings, Jan 1 as adjusted	960
Add: Net Income	804
Less: Dividends	-500
Retained Earnings, Dec 31	1,264