Treasury Stock Accounting and Examples
What is Treasury Stock Accounting?
Treasury stock in accounting
Treasury stock is referred to as the shares that the company (issuer) buys back from its shareholders. It is also known as treasury shares or reacquired stock. The result of this is that the total number of outstanding shares in the open market decreases, that is, shares owned by others, thereby returning their ownership to the company. These shares are issued but they are no longer outstanding and the company does not include them in the distribution of dividends or the calculation of earnings per share (EPS). It also does not have a vote at a shareholders’ meeting.
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The issuer may then retire the stocks or resell the treasury shares at a later date. When determining the number of issued and outstanding shares reported in the company’s financial statements, treasury stock falls under the category of issue. The amount of cash a company pays to buy back treasury shares is recorded in a contra equity account and this appears in the equity section of the balance sheet. Treasury shares can either be common stock or preferred stock that the company reacquires.
The amount of treasury shares that a company should buy back is usually governed by the Securities and Exchange Commission of a nation or in other words, a nation’s regulatory body. Since public shareholders no longer possess these shares, they are not included in dividend payments or earnings per share calculations. Dividends are part of a company’s profit that is being paid out to stockholders in cash or stock. The earnings per share reflect the profitability of a company.
As earlier stated, treasury shares can be retired or resold in the open market. When shares are retired, they are permanently canceled and cannot be reissued in the future. Once these shares are retired, they are no longer recorded as treasury shares on the company’s financial statements. On the other hand, non-retired treasury shares can be reissued through stock dividends, employee compensation, or capital raising.
Treasury stock accounting
When a company initially issues stock, the equity section of the balance sheet is increased through a credit to common stock as well as the additional paid-in capital accounts. The common stock accounts reflect the par value of shares while the additional paid-in capital account shows the excess value received over the par value. Because of the double-entry bookkeeping, the offset of this journal entry is a debit to increase cash or other assets in the amount of the consideration that the shareholders received.
As earlier stated, treasury shares reduce the total equity of shareholders and are generally named treasury stock or equity reduction. There are two methods by which one can account for treasury shares. These methods are the cost method and the par value method.
Cost method of accounting for treasury stock
The cost method makes use of the value that the company paid during the repurchase of the shares and does not take into account their par value. Here, the cost of the treasury stock is included within the stockholders’ equity portion of the balance sheet. It is common for stocks to have a minimum par value such as $1 or $2, but sell and be repurchased for more. The cost method is the most widely used and it is a very simple accounting method for the repurchase of stock.
Par value method for treasury stock accounting
Under the par value method, at the time of repurchase of shares, the treasury stock account is debited to decrease the total shareholders’ equity in the amount of the par value of shares that the company repurchased. The common stock additional paid-in capital account is also debited to reduce it by the amount originally that the shareholders paid in excess of par value.
The cash account is then credited to the total amount that the company paid out for the share repurchase. The account includes the net amount as either a debit or credit to the treasury additional paid-in capital account which depends on whether the company paid more when repurchasing the stock than the shareholders did initially. The par value method is oftentimes under the assumption that the treasury shares have either been or will be retired. Here, the treasury stock’s par value is subtracted from the paid-in capital.
Treasury stock example
A company had initially sold 5,000 shares of common stock with a $1 par value of $41 per share. It had $5,000 common stock which is 5,000 shares multiplied by $1 par value, and $200,000 common stock which is 5,000 shares x ($41 – $1) paid in excess of par on its balance sheet. This company has excess cash and feels that its stock is trading below its intrinsic value. Because of this, it decided to repurchase 1,000 shares of its stock at $50 for a total value of $50,000.
The repurchase of stocks brought about a treasury stock contra equity account. Under the cash method, the treasury account will be debited for $50,000, and the cash account credited for $50,000. Under the par value method, treasury stock will be debited for $1,000, that is, 1,000 shares multiplied by $1 par value. The common stock additional paid-in capital will be debited for $49,000 which is 1,000 shares x ($50 repurchase price – $1 par value) and cash will be credited for $50,000.
Under both the cash and the par value methods, the equity of the total shareholders is decreased by $50,000. Assuming that the total sum of this company’s equity accounts including common stock, additional paid-in capital, and retained earnings was $500,000 before the share buyback, the repurchase will bring the total shareholders’ equity down to $450,000.
Treasury stock on the balance sheet
The shareholders’ equity section has two major headings. These headings are the paid-in capital and retained earnings. Treasury stock is posted under its own heading in the stockholders’ equity section, which is below the retained earnings heading.
If there is a significant change in the company’s financial status from when the stock was initially sold, there may be a need for the stock to be revalued in order to accurately reflect the current value. The treasury stock account is debited while the cash account in the asset section is credited.
