Brown Company purchased common stock in Black Company. Brown Company treats the

Question

Brown Company purchased common stock in Black Company. Brown Company treats the investment as available-for-sale securities. During the current year, Black Company earned $4,000,000 and paid dividends of $1,000,000. Assume that Brown Company owns 10% of the outstanding shares of Black Company. Black Company's net income will affect Brown Company by ________.


A) increasing cash and investments by $400,000

B) increasing stockholders' equity and investments by $400,000

C) increasing cash and stockholders' equity by $400,000

D) no effect

What is the reasoning behind your answer?

Explanation / Answer

Key point: Brown Company owns only 10% of Black Company's common stock.

When accounting for corporations that own other corporation's stock, ownership is divided into three categories:
-noninfluential ownership (less than 20%)
-influential ownership (between 20%-50%)
-controlling influence (over 50%)

Since Brown Company owns a noninfluential amount, Black's net income does not affect Brown in any way.

Brown is only affected by Black's distribution of dividends.

It is important to remember that Available-for-Sale stock (aka securities) is somewhat a "miscellaneous" account, meaning that managers can place short- or long-term securities in this account. Furthermore, we account for AFS (Available for Sale) securities using the Fair Market Value method, meaning that we adjust the value of the stock in our balance sheet periodically.

See this study guide for a complete breakdown of all security types by category:

http://www.flickr.com/photos/68942468@N03/6273650353

Related Questions

Navigate

• Browse (All)
• Browse B
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.