Investor Inc. owns 40 percent of Alimand Corporation. During the calendar year 20X5, Alimand had net...
Investor Inc. owns 40 percent of Alimand Corporation. During the calendar year 20X5, Alimand had net earnings of $100,000 and paid dividends of $10,000. During 20X5, the market value of Alimand’s stock remained unchanged. Investor mistakenly recorded these transactions by carrying the investment at fair value rather than using the equity method of accounting. What effect would this have on the investment account, net earnings, and retained earnings, respectively?
a. Understate, overstate, overstate.
b. Overstate, understate, understate.
c. Overstate, overstate, overstate.
d. Understate, understate, understate.
3. A corporation using the equity method of accounting for its
investment in a 40 percent-owned investee, which earned $20,000 and
paid $5,000 in dividends, made the following entries:
Investment in Investee 8,000
Income from Investee 8,000
Cash 2,000
Dividend Revenue 2,000
What effect will these entries have on the investor’s statement of
financial position?
a. Financial position will be fairly stated.
b. Investment in the investee will be overstated, retained earnings will be understated.
c. Investment in the investee will be understated, retained earnings will be understated.
d. Investment in the investee will be overstated, retained
earnings will be overstated.
Homework Answers
Answer
d. Understate, understate, understate.
As the investor owns more than 30% equity method has to be used. By not using the equity method, the investment account is understated, net earnings will also be understated and when the net earnings are understated it will also result in understatement of retained earnings.
Answer
d. Investment in the investee will be overstated, retained earnings will be overstated.
As the investor owns more than 30% equity method has to be used. It will result in overstated investment in investee by $8,000 (20000*40%)and also result in overstated retained earnings by $8,000 (20000*40%)
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