Overview
In this article, we will cover the accounting for treasury stock. Before jump to detail, let’s understand the overview as well as the key definition of treasury stock.
Modern businesses structures have evolved greatly. There are many forms of businesses that are common today. These may include forms such as sole proprietorship, partnership or company. Sole proprietorship commonly known as an entity that has a single owner. The single owner invests in the business initially and owns the business until the business is sold or another owner joins the business. All the profits and losses of the business are fully borne by the owner. Sole proprietorship is the simplest form of business.
Partnerships, on the other hand, are businesses that have more than a single owner. The owners of a partnership are known as its partners. These partners come together and invest in the business. However, these investments may be of different amounts. Any profits or losses are distributed among the partners depending on a set percentage. The percentage of profits or losses attributable to a single partner is decided when the partnership agreement is signed. Every time a partner joins or leaves the business, the partnership agreement is renewed.
In their simplest forms, sole proprietorships and partnerships are unlimited liability businesses. This means that when the business winds up, all the liabilities of the business are transferred to its owners. For sole proprietorships, all the liabilities are taken by the single owner of the business, while for partnerships, these liabilities are distributed among the partners based on their percentage of profits or losses in the partnership agreement. There are other types of partnerships that limit the liabilities of one of the partners or all of them.
The most advanced forms of businesses are companies or corporations. Companies can have a single owner or hundreds of owners. The owners of companies are known as its shareholders. These shareholders buy the ownership of the company in form of shares. These shares are initially issued by the company and subsequently traded on the stock market. Any person can buy or sell their shares on the stock market without their transaction having any affect on the company or its activities.
Once the shares of the company are issued, the company cannot regulate who owns their shares. However, some times, companies may choose to repurchase their shares from its shareholders. The company can choose to either retire these shares or resell them in the future. When shares are kept with the intention of future resale, these shares are known as treasury stock.
What is Treasury Stock?
Treasury stock, also known as reacquired stock, represents shares of the company that have been reacquired from the market. Reacquiring shares decreases the number of outstanding shares in the market. A reduction in the number of outstanding shares of a company can increase the demand of the company’s shares in the market. Furthermore, it can also affect ratios such as the Earnings Per Share (EPS) ratio of the company positively, thus, further making the shares of the company attractive. Treasury stock is recorded as an asset in the company’s books and the company may choose to reissue these shares in the market in the future.
Companies buy their share back for many reasons. These reasons may include blocking any takeover attempts that the company’s management or existing owners do not want to go through. Similarly, companies, that are publicly listed, and want to go private may also buy their shares back to decrease their number of shareholders. Sometimes, company management may choose to buy the shares of a company back when they have excess cash that they cannot find use for. Finally, some companies may have a policy of buying their shares back when the prices of the shares fall in the stock market.
There are many ways to buy shares back. The simplest way for companies is to reacquire any outstanding shares of the company directly from the market. The company may also choose to reacquire its shares through a tender offer to its shareholders. In this method, the company offers it shareholders to sell their shares back to the company at a specified date and price. Any shareholders that are willing to take up the offer submit their application for their shares to be reacquired. Companies may also choose to give a Dutch auction tender offer to their shareholders. In this method, the company offers it shareholders a range within which they can bid to sell their shares. Finally, companies can also reacquire their shares by directly negotiating with their shareholders. This method is used for shareholders with large holdings.
When it comes to accounting for treasury stock, there are two methods that can be used. These methods are the cost method and the par value method of treasury stock. The cost method and par value are used on the assumption that the shares that have been reacquired will be resold in the future. If the company intends to retire the repurchased shares, these methods cannot be used to account for the shares as no treasury stock will exist.
Cost Method of Treasury Stock
The cost method of treasury stock is the most commonly used method of accounting for treasury stock. In this method of accounting for treasury stock, a separate treasury stock account is established. Any shares that are bought back are recorded in the treasury stock account with the full amount paid for repurchase. The repurchase of shares is viewed as a temporary reduction in shareholders’ equity. The treasury stock account is kept active until the sales are resold.
If the total sales proceeds obtained from the resale of treasury stock exceed the original cash given to buy these shares back, the excess gain is taken to the additional paid-in capital account. However, in case of losses, only losses equal or below the total balance of the additional paid-in capital account are set off against the balance. If the total losses on the transaction exceeds the total balance of the additional paid-in capital account, the excess losses are set off against retained earnings account. Treasury stock transactions can only reduce the retained earnings of a company and cannot increase them back.
Example
A company ABC Co. bought a total of 5,000 of its shares back from its shareholders at $20 per share. The par value of ABC Co.’s shares is $10 per share. These shares were originally issued by ABC Co. for $12 per share. The company uses the cash method of accounting for treasury stock. At the date of repurchase, the accounting entries of the transaction will be as follows:
| Account Name | Debit US$ | Credit US$ |
| Treasury Stock (5,000 shares x $20 per share) | 100,000 | |
| Cash (5,000 shares x $20 per share) | 100,000 |
After a few months, if the company resells these shares back at $25 per share. Any gains made due to the resale of the treasury stock will be taken to the additional paid-in capital account. The additional paid-in capital account is a reserve account that can also be used to set off any future losses on treasury stock resale. The accounting treatment for the resale is as follows:
| Account Name | Debit US$ | Credit US$ |
| Cash (5,000 shares x $25 per share) | 125,000 | |
| Treasury Stock (5,000 shares x $20 per share) | 100,000 | |
| Additional paid-in capital ($125,000 – $100,000) | 25,000 |
However, should the company resell these shares back at $15 per share and make a loss on the resale, the accounting treatment will be different. If the company has a balance of $25,000 or more in its additional paid-in capital account, the accounting treatment will be as follows:
| Account Name | Debit US$ | Credit US$ |
| Cash (5,000 shares x $15 per share) | 75,000 | |
| Additional paid-in capital ($75,000 – $100,000) | 25,000 | |
| Treasury Stock (5,000 shares x $20 per share) | 100,000 |
Similarly, for the same loss, assuming the company only has a balance of $15,000 in its additional paid-in capital account, the accounting treatment will be as follows:
| Account Name | Debit US$ | Credit US$ |
| Cash (5,000 shares x $15 per share) | 75,000 | |
| Treasury Stock (5,000 shares x $20 per share) | 15,000 | |
| Retained Earnings ($25,000 loss – $15,000 already set off) | 10,000 | |
| Treasury Stock (5,000 shares x $20 per share) | 100,000 |
Finally, if ABC Co. does not have any prior balance in its additional paid-in capital account, the accounting entries will be as follows:
| Account Name | Debit US$ | Credit US$ |
| Cash (5,000 shares x $15 per share) | 75,000 | |
| Retained earnings ($75,000 – $100,000) | 25,000 | |
| Treasury Stock (5,000 shares x $20 per share) | 100,000 |
Par Value Method of Treasury Stock
The treasury stock par value method is an alternate method to account for treasury stock. The treasury stock par value method is not as widely used and may not be allowed under the rules of certain countries or states. Under this method of accounting for treasury stock, only the par value of the shares reacquired are debited to the treasury stock account at the time of reacquisition. Any excess amount paid above the par value of the shares are set off against the additional paid-in capital account. Any remaining amount in excess of the balance in the additional paid-in account is set off against the retained earnings balance of the company.
When these shares are resold or reissued, the treasury stock is credited for the par value of these shares. Any additional receipts above the par value of the shares are taken to the additional paid-in capital account. However, this excess amount cannot be used to increase the retained earnings balance even if the reacquisition of the shares were set off against retained earnings. The issued shares are treated as if they are being issued for the first time with the treasury stock account being credited instead of the share capital account.
Example
A company XYZ Co. reacquired 10,000 of its shares at a price of $30 per share. The par value of these shares in the books of XYZ Co. is $10. The company initially issued the shares for $20. In order to account for the treasury stocks, XYZ Co. uses the treasury stock par value method. Assuming the company still has an additional paid-in capital balance of $200,000 or above, at the date of repurchase, the accounting entries will be as following:
| Account Name | Debit US$ | Credit US$ |
| Treasury Stock (10,000 shares x $10 par value) | 100,000 | |
| Additional paid-in capital [10,000 shares x ($30 purchase price – $10 par value)] | 200,000 | |
| Cash (10,000 shares x $30 per share) | 300,000 |
For the same example, assuming the company only has a balance of $50,000 remaining in its additional paid-in capital account, the accounting treatment will be as follows:
| Account Name | Debit US$ | Credit US$ |
| Treasury Stock (10,000 shares x $10 par value) | 100,000 | |
| Additional paid-in capital (minimum of $200,000 excess above par or $50,000 remaining balance) | 50,000 | |
| Retained Earnings ($200,000 excess above par amount – $50,000 set off against additional paid-in capital balance) | 150,000 | |
| Cash (10,000 shares x $30 per share) | 300,000 |
Finally, if XYZ Co. do not have any remaining balance in its additional paid-in capital account, the accounting treatment will be as follows:
| Account Name | Debit US$ | Credit US$ |
| Treasury Stock (10,000 shares x $10 par value) | 100,000 | |
| Retained earnings [10,000 shares x ($30 purchase price – $10 par value)] | 200,000 | |
| Cash (10,000 shares x $30 per share) | 300,000 |
After a few months, XYZ Co. resold these shares at $35 per share, the accounting entries will be as below:
| Account Name | Debit US$ | Credit US$ |
| Cash (10,000 shares x $35 per share) | 350,000 | |
| Treasury Stock (10,000 shares x $10 par value) | 100,000 | |
| Additional paid-in capital [10,000 shares x ($35 per share – $10 par value)] | 250,000 |
When reselling the shares, regardless of whether the company makes a gain or loss on the resale, the accounting treatment will be the same under the treasury stock par value method.
Difference between cost and par value method of treasury stock
The difference between the cost and par value method of accounting for treasury stock is in their treatment of reacquisitions and resales differently. Under the cost method of accounting for treasury stock, the company records the full payment made for the repurchase of shares in the treasury stock account. On the other hand, under the treasury stock par value method of accounting for treasury stock, the company only records the par value of the stock in the treasury stock account. Any excess paid for the shares above the par value is set off against the additional paid-in capital account first and any remaining amount is set off against the company’s retained earnings.
For resales, under the cash method of accounting for treasury stock, the company takes any gains or losses on the resale to the additional paid-in capital account. In case of a loss, if the additional paid-in capital account balance is below the loss made on the resale, any additional amount is set off against the retained earnings account. In case a company uses the treasury stock par value method, the treasury stock is only credited for the par value of the shares while any excess amount received over the par value is taken to the additional paid-in capital account just like new share issues are treated.
Conclusion
Treasury stock is an account created for any shares that are repurchased by a company only if the company intends to resell those shares. If the company plans to retire these shares, treasury stock accounts are not created. Companies may have different reasons to reacquire their shares and can be reacquired using different methods. There are two methods of accounting for treasury stock, the cash method and the par value method. Both methods have different ways of treating reacquisitions and resale of shares.
