Judd, Inc., owns 35% of Cosby Corporation.During the calendar year 2015, Cosby had net earnings of $300,000 and paid dividends of $30,000.Judd mistakenly recorded these transactions using the fair value method rather than the equity method of accounting.What effect would this have on the investment account, net income, and retained earnings, respectively?

Question

Quizplus · Accepted Answer

Judd should use the equity method, which would increase the investment account and net income by 35% of Cosby's net earnings ($105,000) and decrease by 35% of dividends ($10,500). Using the fair value method, Judd would only recognize dividend income, understating the investment account and net income, and consequently retained earnings.

Judd, Inc, Owns 35% of Cosby Corporation