When a company invests in common stock, it can earn income in two primary ways:
Dividend income: When the company receives dividends, it recognizes the income.
Capital gains: When the stock is sold for a higher price than its purchase price, it results in a gain.
Why Option C (Receives dividends) is Correct:
Dividends represent income from an investment in common stock when declared and paid by the issuing company.
Under GAAP and IFRS, dividend income is recognized when received, not when declared.
Companies record dividends as investment income in their income statement.
Why Other Options Are Incorrect:
Option A (Purchases bonds):
Incorrect because purchasing bonds is an investment transaction, not income recognition.
Option B (Receives interest):
Incorrect because interest income applies to bond investments, loans, or deposits, not common stock investments.
Option D (Sells bonds):
Incorrect because selling bonds results in capital gains or losses, not regular investment income from common stock.
IIA Practice Guide – "Auditing Investment & Treasury Activities": Discusses the recognition of investment income.
IFRS 9 (Financial Instruments) & GAAP Standards: Provide guidance on recording dividends as investment income.
COSO Internal Control – Integrated Framework: Emphasizes proper financial reporting and income recognition.
IIA References:
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