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: