Treasury shares, also know as reacquired stock, is an outstanding stock that the issuing company has bought back from the buyers. When this occurs, the total number of open shares on the market decrease and is no longer counted in the earnings per share, or dividend distribution. It is recorded on the balance sheet of a shareholder’s equity section as a contra equity, which will reduce the equity of the shareholder by the amount they paid for the stock. The shares are also no longer counted as voting rights. To fully understand what treasury stock is and how they work, you will need to know:
- How treasury stock shares are recorded.
- Examples of treasury shares.
- The difference between a retired share and a treasury share.
- Why a company would choose to buy back shares.
- What the treasury stock method is.
- Examples of using the treasury stock methods.
How to Record Treasury Stock Shares
At the initial issuance of the stock, a company’s balance sheet will show an increase in the equity section with credit to common stocks and the APIC. The common stock account on the balance sheets will be reflective of the par value of the shares issued. The APIC account will indicate the excess that is received over that value. Since bookkeeping requires a double entry of a debit and a credit, a journal entry will need to be created as a debit to increase cash in the amount received by the shareholders. When you record treasury stocks, they will often be labeled as an equity reduction as it will reduce the total of the shareholder’s equity. Two different accounting methods can be used in the recording of treasury stocks.
- Cost method: To use the cost method, you will use the value paid to the company when the shares were repurchased, and completely ignore the par value of the stock. This will be recorded in the equity portion of the balance sheet. To record using the cash method, you will debit the treasury account to decrease the total amount of the shareholder’s equity and then credit the cash account to record the spending of the company’s money. If you later resell the treasury stock, you will debit this account and credit the treasury account.
- Par method: Another common method is known as the par method. When the repurchase occurs, the stock account will be debited, which will serve the purpose of decreasing the equity of the shareholders, based on the par amount of the shares that have been repurchased. Then the APIC common stock account will receive a debit, which decreases the amount that was originally paid in excess of the par value.
Next, the cash account will be credited with the total amount that the company spent on the repurchase. The final step is a debit or a credit of the net amount of the purchases to the treasury APIC account. Whether it is a debit or credit will depend on whether the company paid more for the stock than shareholders dd when they originally purchased it.
When reissuing treasury stock, you may gain a profit or suffer a loss. In the event you reissue the stock at a profit, you will need to have the entire balance of the reissuance credited back to the paid in capital treasury stock account. If you incur a loss when you reissue the stock you will still need to credit the treasury stock account for the total amount, but will only debit it to the cash account for what you sold it for. This will show a loss in the retained earnings to reflect the loss of the shareholder’s equity.
What Are Some Examples of Treasury Shares?
One example of a treasury share occurrence would be XYZ company selling off 4,000 shares of their common stock at a par value of $1, at $32 per share. So the company had $4,000 common stock and $128,000 common stock APIC on its company balance sheet. They may have excess cash and feel that their stock is now trading below its intrinsic value. They may then decide to repurchase 500 shares of their stock at the current price of $40 to raise their per-share price, making it more attractive to investors. This will cost $20,000.
When this repurchase occurs, a treasury stock contra account will need to be created. If the company uses the cash method for accounting, then they will need to debit its treasury account $40,000 and credit their cash account $40,000. If they choose to use the par method of accounting, then they will reduce the stock by the total par value of $500. This would mean the common stock APIC account will be debited $39,500, while crediting their cash account the full $40,000. In both cases, the shareholder equity will be decreased by $40,000. If the company’s retained earnings was $400,000, it would be reduced to $360,000 after the repurchase.
What is the Difference Between a Retired Share and a Treasury Share?
Treasury stock can be bought back and held either for resale, or retires. The difference is, that when stock shares are retired, they become permanently issued and have no possibility of being reissued later. Retiring the stock also removes them from the company’s financial statements. Non-retired stock shares can later be reissued as:
- Stock dividends.
- Capital raising.
- Employee compensation.
Why Would a Company Choose to Buy Back Shares?
A company may choose to buy back shares of its stock for a number of reasons. One of the most common reasons for buybacks is to reduce the amount of open shares on the market, which will, in turn, increase the value of the stock that each of the shareholders currently has. Fewer stocks open to trade means that the ones that are held will rise in value. This can also help make a company a more attractive investment for new investors. Many businesses will use this as a way to reward their current shareholders in lieu of a cash dividend.
There are other company motives behind buybacks, as well. They may have some sought-after executives that they want to reward with stock options to increase their compensation package. By making this a part of their benefits package, they are more likely to attract the hires they are looking for in the future as well.
Buybacks can also be part of a corporate defense strategy that can help them to avoid a possible hostile takeover better. When there are fewer shareholders, it makes it more difficult for buyers to acquire enough company stock to take the majority ownership position away from others.
A final reason that a company may engage in a buyback is to keep the treasury stock on its books. They may be looking to retire it eventually, or possibly sell it off at a higher price at a later date.
What is the Treasury Stock Method?
Companies may choose to use the treasury stock method to help them compute the number of new shares they may be able to create using the unexercised in-the-money warrants and options. These additional shares will go into the calculation of the diluted earnings per share. When using this method, it is assumed that the proceeds that the company will make from the in-the-money option exercise will be used to repurchase more of the common shares on the open market.
To perform the treasury stock method, the basic share count that is used to calculate the earnings-per-share of the company, you must increase the earnings-per-share as a result of the outstanding in-the-money options and warrants. This will entitle the holder of the options or warrants to purchase more of the company’s common shares at a lower price than the current market value. In this case, the treasury method will need to be used to calculate the diluted earnings-per-share.
The number of additional shares that have been bought back will then need to be added to the basic share count. The entry will need to reflect the difference between the assumed share count from the exercising of the warrant and options, and the share count had it been purchased at the price on the open market.
An Example Using the Treasury Stock Method
An example of calculating using the treasury stock method would be if XYZ company reports that there are 200,000 shares outstanding on the market. They had a total net income of $1 million in the previous year and 20,000 in-the-money options and warrants that had an average exercise price of $60. Assume that the average market share price in the open market for the stock was $110 per share. When you calculate the company’s basic EPS, you will get $5. This does not take into account the options and warrants.
When you apply the treasury method, the company will receive $1,200,000 if it exercises the options and warrants, which can then be used to buy 10,909 shares of stock at the current market value of $110. This means they will have the 200,000 basic shares plus the 10,909 additional shares, which will create a diluted EPS of $4.74.
Understanding what treasury stocks are and how to account them can help you better understand the buyback process and how it affects investors. Looking to find out more information on treasury stocks? Sign up for our webinar or download our free e-book.