A parent corporation that uses the equity method of accounting for its investment in a 40 percent owned subsidiary,which earned $20,000 and paid $5,000 in dividends,made the following entries: $\begin{array}{lll}
\text {Investment in Associate. }&8,000\
\text { Investment revenue.}&& 8,000\
\text {Cash. }&2,000\
\text {Dividend revenue }&&2,000 \
\end{array}$ What effect will these entries have on the parent's balance sheet?

Question

Quizplus · Accepted Answer

The parent should recognize 40% of the subsidiary's earnings as investment revenue, which is $8,000. However, dividends received should reduce the investment account, not be recognized as revenue. Therefore, the investment is overstated, and retained earnings are overstated due to incorrect recognition of dividend revenue.

A Parent Corporation That Uses the Equity Method of Accounting