Final answer:
Under the equity method, an investor increases their investment account based on their share of investee's earnings, not by dividends or changes in fair value of stock. Dividends received reduce the investment's carrying amount, and capital gains or losses are not considered in the equity method accounting.
Step-by-step explanation:
When an investor uses the equity method to account for investments in common stock, the investment account will be increased when the investor recognizes their share of the investee's earnings that are attributable to them, not when dividends are received or when there is an increase or decrease in the fair value of the investee's stock. Dividends received from the investee actually reduce the carrying amount of the investment, while changes in the fair value of the investee's stock are not recognized in earnings under the equity method unless it results in the recognition of impairment. Losses incurred by the investee will decrease the investor's carrying amount of the investment.
Investors receive a rate of return on their investment in two main forms: dividends and capital gains. A dividend is a direct payment made to shareholders as a part of the company's profits. A capital gain occurs when an investment is sold for more than its purchase price.