Phelps Co.uses the sophisticated equity method to account for the 80% investment in its subsidiary Shore Corp.At the time of the acquisition, the fair values of the net asset required approximated their book values.Based upon the following information, what amount does Phelps Co.record as subsidiary income
$\begin{array}{lr}
\text { Phelps internally generated income: } & \$ 250,000 \
\text { Shore internally generated income: } & \$ 50,000 \
\text { Intercompany profit on Shore beginning inventory: } & \$ 10,000 \
\text { Intercompany profit on Shore ending inventory: } & \$ 15,000
\end{array}$

A)$50,000
B)$44,000
C)$40,000
D)$36,000

Question

Phelps Co.uses the sophisticated equity method to account for the 80% investment in its subsidiary Shore Corp.At the time of the acquisition, the fair values of the net asset required approximated their book values.Based upon the following information, what amount does Phelps Co.record as subsidiary income
$\begin{array}{lr}
\text { Phelps internally generated income: } & \$ 250,000 \
\text { Shore internally generated income: } & \$ 50,000 \
\text { Intercompany profit on Shore beginning inventory: } & \$ 10,000 \
\text { Intercompany profit on Shore ending inventory: } & \$ 15,000
\end{array}$

A)$50,000
B)$44,000
C)$40,000
D)$36,000

Quizplus · Accepted Answer

Under the equity method, Phelps Co. would recognize 80% of Shore's internally generated income, adjusted for the impact of intercompany profits in inventory. Shore's income is $50,000. The beginning inventory intercompany profit of $10,000 (which inflated last year's income) must be subtracted, and the ending inventory intercompany profit of $15,000 (which will inflate this year's income) must be added back. Thus, the calculation is 80% of ($50,000 - $10,000 + $15,000) = 80% of $55,000 = $44,000. However, the correct calculation should not add back the ending inventory profit, as it inflates this year's income but is not realized by the parent. Therefore, the calculation should be 80% of ($50,000 - $10,000) = 80% of $40,000 = $32,000. The provided choices do not match this calculation, indicating a possible misunderstanding in the explanation process. Given the options, the closest correct approach based on the standard method of adjusting for intercompany profits would be to adjust for the beginning inventory profit, not the ending, which is not the standard approach. The correct answer should reflect the equity method's treatment of subsidiary income and intercompany transactions, but none of the provided choices accurately reflects the correct calculation based on standard accounting practices. Therefore, the explanation sought to correct the approach but found an inconsistency in the application of accounting principles to the provided options.

Phelps CoUses the Sophisticated Equity Method to Account for the 80