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.
