Treasury stock refers to shares that a company has previously issued and then repurchased from the market. When a company decides to buy back its own stock, it does so at the current market price. For instance, if ABC Company repurchases its shares at $50 each, this price reflects the market value at the time of the buyback.
It is important to understand that treasury stock does not receive dividends. Dividends are only paid on outstanding shares, which are the shares still held by the public. The relationship between issued shares, outstanding shares, and treasury stock can be expressed with the equation:
T_{stock} = Issued - Outstanding
Here, treasury stock (Tstock) is calculated by subtracting the number of outstanding shares from the total issued shares. This means that treasury stock represents the shares that the company has repurchased and are no longer available to the public.
A common misconception is that treasury stock is considered an asset. However, it is classified as a contra equity account. This means that treasury stock has a debit balance, which is contrary to the typical credit balance of equity accounts. As a result, treasury stock reduces the overall equity of the company, reflecting the repurchase of its own shares.
When accounting for treasury stock, the focus will be on the cost method, which records the repurchase at the price paid. There is also a par value method, but that will be covered in more advanced accounting courses. Understanding these concepts is crucial for accurately reflecting a company's equity position and financial health.