Mayberrry Company owns 40% of Xnau Corporation's outstanding common stock. During the calendar year 2018, Xnau had net earnings of $500,000 and paid dividends of $60,000. Mayberry mistakenly recorded these transactions using the fair value method rather than the equity method of accounting. What effect would this have on Mayberry's investment account, net income, and retained earnings, respectively?

Question

Quizplus · Accepted Answer

Under the equity method, Mayberry should recognize its share of Xnau's net earnings, which increases the investment account and net income, and dividends received reduce the investment account but do not affect net income directly. Using the fair value method instead, Mayberry would not adjust its investment account for its share of Xnau's earnings, leading to an understatement of the investment account and net income. Since net income feeds into retained earnings, retained earnings would also be understated.

Mayberrry Company Owns 40% of Xnau Corporation's Outstanding Common Stock