Treasury Stock: Videos & Practice Problems

Treasury stock refers to shares that a company has repurchased from the public at the current market price, which do not receive dividends. The equation for treasury stock is $T=I-O$, where T is treasury stock, I is issued shares, and O is outstanding shares. Treasury stock is a contra equity account with a debit balance, reducing total equity. When reselling, any difference between the repurchase and resale price affects additional paid-in capital (APIC) rather than income statements.

Treasury Stock

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 (T_stock) 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.

Repurchasing Stock into Treasury

In treasury stock transactions, companies can repurchase their own shares from the market and later resell them, impacting both their cash and equity accounts. When a company like Apartment Depot repurchases shares, it records the transaction using the cost method, which focuses on the total expenditure rather than the par value of the stock.

For instance, if Apartment Depot repurchases 10,000 shares of common stock with a par value of $0.50 at a market price of $25, the total cost of the repurchase amounts to:

Total Cost = Number of Shares × Market Price = 10,000 \times 25 = 250,000

This $250,000 is recorded as a debit in the treasury stock account, which is a contra equity account, indicating a reduction in total equity. The corresponding credit entry is made to the cash account, reflecting the outflow of cash used to buy back the shares. The journal entry would look like this:

Debit: Treasury Stock  $250,000Credit: Cash           $250,000

Through this transaction, the company reduces its assets (cash) by $250,000 and simultaneously decreases its equity by the same amount, maintaining the balance in the accounting equation. This process illustrates how treasury stock transactions can affect a company's financial statements by lowering both assets and equity.

Selling Treasury Stock from the Treasury

When a company repurchases its own shares, these shares are recorded as treasury stock, which is a contra equity account. In this scenario, the Apartment Depot repurchased 10,000 shares of common stock with a par value of $0.50 at a market price of $25 per share, resulting in a total treasury stock value of:

$$\text{Total Treasury Stock} = \text{Number of Shares} \times \text{Purchase Price} = 10,000 \times 25 = 250,000$$

Now, the company is reselling 5,000 of these treasury shares at a higher price of $30 per share. The cash generated from this sale can be calculated as follows:

$$\text{Cash from Sale} = \text{Number of Shares Sold} \times \text{Selling Price} = 5,000 \times 30 = 150,000$$

Since the company sold half of the treasury stock it had repurchased, the reduction in the treasury stock account will be:

$$\text{Reduction in Treasury Stock} = \text{Total Treasury Stock} \times \frac{\text{Shares Sold}}{\text{Total Shares Repurchased}} = 250,000 \times 0.5 = 125,000$$

In this transaction, the cash received ($150,000) exceeds the reduction in the treasury stock account ($125,000) by $25,000. This difference is not recorded as a gain on the income statement; instead, it is credited to Additional Paid-In Capital (APIC), which reflects an increase in equity. The journal entries for this transaction would be:

• Debit Cash: $150,000
• Credit Treasury Stock: $125,000
• Credit Additional Paid-In Capital: $25,000

This approach ensures that the accounting equation remains balanced, with total assets increasing by $150,000 and total equity also increasing by $150,000. It is important to note that when treasury stock is sold, the company must accurately reflect the proportion of shares sold relative to the total shares repurchased, as this affects the treasury stock balance and the corresponding equity accounts.

Here’s what students ask on this topic:

What is treasury stock and how does it affect a company's equity?

Treasury stock refers to shares that a company has repurchased from the public at the current market price. These shares do not receive dividends and are not considered outstanding shares. Treasury stock is recorded as a contra equity account, meaning it has a debit balance and reduces the total equity of the company. The equation for treasury stock is:

$T=I-O$

where $T$ is treasury stock, $I$ is issued shares, and $O$ is outstanding shares. By repurchasing its own shares, a company lowers its equity, as the treasury stock account increases with a debit balance.

How is treasury stock recorded in journal entries?

When a company repurchases its own shares, the journal entry involves debiting the treasury stock account and crediting cash. For example, if a company repurchases 10,000 shares at $25 each, the entry would be:

Debit: Treasury Stock $250,000

Credit: Cash $250,000

This entry reduces both the company's cash (an asset) and its equity, as treasury stock is a contra equity account. When the company later resells the shares, the entry involves debiting cash and crediting treasury stock for the proportionate amount, with any difference affecting Additional Paid-In Capital (APIC).

What happens when a company resells its treasury stock at a different price?

When a company resells its treasury stock at a different price, the difference between the repurchase price and the resale price affects Additional Paid-In Capital (APIC). For example, if a company repurchased shares at $25 each and later resells them at $30 each, the journal entry would be:

Debit: Cash $150,000 (for 5,000 shares at $30 each)

Credit: Treasury Stock $125,000 (proportionate amount for 5,000 shares)

Credit: APIC $25,000 (difference between cash received and treasury stock reduction)

This entry increases both cash and equity, with the APIC account reflecting the gain from the resale.

Why is treasury stock considered a contra equity account?

Treasury stock is considered a contra equity account because it reduces the total equity of the company. Unlike regular equity accounts, which have credit balances, treasury stock has a debit balance. When a company repurchases its own shares, it records the transaction by debiting the treasury stock account, thereby lowering the overall equity. This is because the repurchased shares are no longer outstanding and do not contribute to the company's market value or dividend payments. The contra equity nature of treasury stock ensures that the financial statements accurately reflect the reduction in equity due to the repurchase.

Do treasury stock transactions affect the income statement?

No, treasury stock transactions do not affect the income statement. When a company repurchases or resells its own shares, the transactions are recorded in the equity section of the balance sheet. Any difference between the repurchase price and the resale price is adjusted through Additional Paid-In Capital (APIC) rather than being reported as a gain or loss on the income statement. This treatment ensures that the company's net income is not impacted by transactions involving its own equity, maintaining a clear distinction between operational performance and equity management.