Olivia Co. owns 4,000 of the 10,000 outstanding shares of Hobbitt Corp. common stock and exercises significant influence over the company. During 2006, Hobbitt earns $80,000 and pays cash dividends of $30,000. If the beginning balance in the investment account was $160,000, the balance at December 31, 2006 should b

Question

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Since Olivia Co. exercises significant influence over Hobbitt Corp., the equity method of accounting should be used to record the investment in Hobbitt. Under the equity method, the investment account is increased by the investor's share of the investee's earnings and decreased by the investor's share of the investee's dividends.

For 2006, Olivia Co.'s share of Hobbitt's earnings would be 4,000/10,000 x $80,000 = $32,000. This amount should be added to the beginning investment balance of $160,000 to get an investment account balance of $192,000.

Olivia Co.'s share of Hobbitt's dividends would be 4,000/10,000 x $30,000 = $12,000. This amount should be subtracted from the investment account balance to arrive at the ending balance of $180,000. Therefore, the correct answer is C.

Olivia Co Owns 4,000 of the 10,000 Outstanding Shares of Hobbitt