If an investor mistakenly uses the fair value method instead of the equity method, what will the effects be on their accounts?

When using the fair value method in place of the equity method, the investor typically recognizes dividends received as income rather than their proportionate share of the investee's profits. This results in a difference in how income and investments are recorded.

With the fair value method, the investment is recorded at its fair value, which might not reflect the underlying profitability of the investee. Consequently:

• The investor’s share of income would be understated because it is limited to dividends received, ignoring any additional profits from the investee that could have increased the investment value.
• The investment account itself would be understated, as it does not account for the investor's share in the investee's retained earnings.
• Overall equity would be understated because the investor's profits reflected in net income are lowered, which in turn affects the retained earnings in equity.

Thus, using the fair value method instead of the equity method typically leads to an overall understatement of income, investment value, and equity. Therefore, the understanding that all three components (income, investment account, and equity) are understated supports the correctness of this choice.