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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.

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