Question

Fey Corporation uses the equity method of accounting for its investment in a 30%-owned investee that earned $56,000 and paid $18,000 in dividends.

As a result, Fey Corporation made the following entries:

Equity Investment16,800
Equity Income16,800
Cash5,400
Dividend Revenue5,400

What effect will these entries have on Fey Corporation's balance sheet?

A. Investment understated; retained earnings understated

B. Investment overstated; retained earnings understated

C. Investment overstated; retained earnings overstated

D. No effect

Answer 1

The answer is : C. Investment overstated; retained earnings overstated

Step-by-step explanation:

Under the equity method of accounting, Fey Corporation should record the correct entry as below:

Dr Equity Investment 16,800

Cr Equity Income 16,800

Dr Cash 5,400

Cr Equity Investment 5,400

As a result, Investment account has been overstated by $5,400 while Dividend Revenue account has been overstated by $5,400. The overstating in Dividend Revenue will subsequently result to the overstating in Retained Earnings account through closing entry.

So, C. Investment overstated; retained earnings overstated is the correct answer.