Question

Frisco 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, Frisco Corporation made the following entries: Equity Investment 16,800 Equity Income 16,800 Cash 5,400 Dividend Revenue 5,400 What effect will these entries have on Frisco Corporation's balance sheet? a. Investment understated, retained earnings understated b. Investment overstated, retained earnings understated c. Investment overstated, retained earnings overstated

Answer 1

Answer:

b. Investment overstated, retained earnings understated

Explanation:

The investment overstated and the retained earnings understated due to the entries because the dividends paid by the investee company  are affecting the retained earning of the Frisco Corp. which correspond to the income of the company and not to the investee.

The investment must be treated as an asset of long term because of the equity method and the income and the dividend had to be record against the Long Term Asset.

In this way Frisco it's recognizing the earning of the investment and it's increase in the participation due to the income of the investee.

Long Term Asset Investee  16.800  Debit

Long Term Asset Investee Revenue  16.800  Credit  

Cash  5.400  Debit

Long Term Asset Investee  5.400  Credit

Net Long Term Asset  11.400  Debit

By this way the Equity and retained earnings of the Frisco Corp are not affected.