Retired stock (Retirement of treasury stocks)
What is a retired stock?
The retirement of treasury stock involves the buyback of a company’s own shares and then permanently canceling them to make them unavailable on the open market. Treasury stocks that are retired or canceled are also known as terminated stocks or canceled stocks. Therefore, retired shares mean the outstanding shares of a company that have been repurchased by the company after the shares have been issued, and then subsequently cancel the repurchased shares.
Retired shares are also known as canceled shares (or canceled stocks) because the shares that have been repurchased are not kept with the aim of reselling them at a later date rather they are permanently rendered useless; hence the name “retired stocks” or “canceled stocks”. Retirement of shares makes them not available on the open market and the canceled stocks cannot be paid dividends nor have voting rights.
Canceled shares are different from treasury shares (also known as treasury stocks). The major difference between treasury stock and retired stock is that the treasury shares can be resold at a later date but retired shares can be sold in the open market again. Both treasury stocks and canceled stocks have no voting rights and cannot be paid dividends. We will discuss more on the differences and similarities between treasury shares and retired shares later.
Retirement of treasury stock
Retired stocks or retired shares are usually stocks that have been retired from the market and can no longer be traded on the open market. There are many reasons why a company may buy back its shares but one of the key reasons may be to increase the value of the shareholders’ equity. A company buys back its shares and canceled them, thereby reducing the outstanding shares available, this increases the earnings per share and makes it more attractive to investors.
Canceled stocks are generally removed from the tracking system and may no longer be reflected on the company’s financial statements. Retiring shares means that the company no longer has any ownership of the stock, so it can’t sell it or use the stock to borrow money. The securities and exchange commission (SEC) mandates all transfer agents to keep a database of canceled stocks and make them retrievable; by doing this, all retired stocks can be monitored to prevent them from being reissued on the open market again. This helps to prevent fraud associated with retired stocks.
Why would a company retire shares?
When a company decides to retire shares, it generally does so by issuing a notice of retirement to the shareholders. This notice states the number of shares that are being retired and the date on which they will become void. Generally, when a company issues a notice of retirement, it will record the number of retired shares on its balance sheet.
Retirement of shares journal entry using the cost method and par value method
When a company retires shares, it records the transaction as a journal entry. This journal entry includes the following information:
- The number of shares retired
- The value of the shares retired (in dollars)
- The date of the transaction
- The name of the company that retired the shares
There are two methods of journal entry for retired stocks; these are the cost method and the par value method.
Let’s assume Duzzlag Engineering and Construction Company issued 10,000 shares at $15 per share and a par value of $10. After 2 years of being in business, this company repurchased 1,000 shares at $20 per share and retired the stocks.
Given the information above, let us show some examples for the issuing, repurchase and retirement of common stock journal entry.
Example showing the journal entry for purchase of shares using the cost method
When 10,000 shares are issued, the journal entry is as shown below using the cost method:
| Account Name | Debit | Credit |
|---|---|---|
| Cash | 150,000 | |
| Common stock | 100,000 | |
| Additional paid-in capital – common stock | 50,000 |
Example showing treasury shares journal entry using the cost method
When 1,000 shares are repurchased, the journal entry is shown below using the cost method:
| Account Name | Debit | Credit |
|---|---|---|
| Treasury stock | 20,000 | |
| Cash | 20,000 |
Example on retirement of treasury stock journal entry – How to record the entry to reclassify treasury shares as retired shares
When a company buys back its own shares, such shares are classified as treasury stock. The company can also decide to cancel some or all of its treasury stocks. The example below shows the retirement of treasury shares journal entry using the cost method.
When the company decides to retire 1,000 shares, the retired shares journal entry is as shown below using the cost method:
| Account Name | Debit | Credit |
|---|---|---|
| Common stock | 10,000 | |
| Additional paid-in capital – common stock | 10,000 | |
| Retained earnings | 0 | |
| Treasury stock | 20,000 |
Additional paid-in capital associated with 1,000 shares: 1,000 × ($20 – $10) = 10,000
The retained earnings account would be debited with: ($20,000 – $10,000 – $10,000) = 0
Journal entry for purchase of shares using the par value method
When 10,000 shares are issued, the journal entry is shown below using the par value method:
| Account Name | Debit | Credit |
|---|---|---|
| Cash | 150,000 | |
| Common stock | 100,000 | |
| Additional paid-in capital – common stock | 50,000 |
Example showing the journal entry for treasury shares using the par value method
When 1,000 shares are bought back, the treasury shares journal entry using the par value method is as shown below:
| Account Name | Debit | Credit |
|---|---|---|
| Treasury stock | 10,000 | |
| Additional paid-in capital – common stock | 10,000 | |
| Retained earnings | 0 | |
| Cash | 20,000 |
Additional paid in capital associated with 1,000 shares: 1,000 × ($20 – $10) = 10,000
Retained earnings account is debited with: ($20,000 – $10,000 – $10,000) = 0
Example showing the journal entry for retired stocks using the par value method
When 1,000 shares are retired the journal entry using the par value method is shown below:
| Account Name | Debit | Credit |
|---|---|---|
| Common stock | 10,000 | |
| Treasury stock | 10,000 |
Some states in the United States have specific laws on how to account for retired stocks and therefore, may differ from what is stated here.
Advantages of retirement of shares
- Retired stocks mean that the company cannot reissue the canceled stocks again, this means the number of authorized stocks has reduced and therefore, the chances of stock dilution would be low. Dilution of shares is what investors like to avoid.
- Retirement of shares reduces the number of outstanding shares and this is likely to increase the stock price as well. Companies may retire their shares to increase the value of the shares.
Treasury stock vs retired stock
Retired stock and treasury stock are both types of share buybacks. These repurchased shares have different uses for the company. Below are their differences and similarities:
Differences between retired stocks and treasury stock
- Retired stocks have no financial value again to the company whereas treasury shares refer to
- Retired stocks reduce the number of outstanding shares permanently whereas treasury shares reduce the number of outstanding temporarily.
- Treasury shares are financial assets that the company can resell to earn cash but retired stocks are worthless.
- Retired shares cannot be used as stock options for employees but treasury shares can be used as stock options for employees.
- Retired stocks reduce the number of issued shares and outstanding shares but treasury stocks only reduce the outstanding shares.
Similarities between retired stock and treasury shares
- Both are types of share buybacks
- They are both useful to the company in reducing the outstanding shares
- Both cannot be paid dividends
- None contributes to voting rights or ownership of the company; owning treasury shares of retired does not give the company more voting power nor does the company pay itself dividends.
