Updated July 19, 2023
Definition of Treasury Stock
Treasury stocks refer to shares that a company repurchases from the public or retains in its own possession without issuing them to the public. The term “treasury stock” is used because these shares are held in the company’s treasury. This can occur either through buybacks of previously issued shares or by keeping a portion of the authorized shares.
Explanation
When a company repurchases its own shares or holds treasury stocks, it reduces the number of shares available in the market. Consequently, treasury stock is considered a contra-equity account. It impacts the outstanding number of shares in the open market. The number of shares a company can repurchase as treasury stocks or keep in its own treasury is mostly regulated by a national regulatory authority in different countries.
How to Record Treasury Stock
They are two methods of recording these stocks:
1. Cost Method
The cost method ignores the par value of the share of the company. Under the cost method, if the treasury stock is purchased, the following entry is passed with the actual amount of purchase.
| Dr | Treasury stock (Repurchase amount) |
| Cr | Cash(Repurchase amount) |
When these shares are sold at a later stage, the following entry is passed:
Case: Sales consideration exceeds the cost of purchase
| Dr | Cash (Amount received) |
| Cr | Treasury stock (Repurchase amount) |
| Cr | Additional paid-in capital (Difference) |
Case: Sales consideration is less than the cost of purchase
| Dr | Cash (Amount received) |
| Dr | Additional paid-in capital (Balance available) |
| Dr | Retained earnings (Difference if any) |
| Cr | Treasury stock (Repurchase amount) |
If the additional paid-in capital amount is insufficient, then only the balance amount is charged to retained earnings.
2. Par Value Method
Under par value method, the following entry is passed at the time of repurchase:
| Dr | Treasury stock (Par Value) |
| Dr | Additional paid-in capital (Difference) |
| Cr | Cash (Repurchase amount) |
In this scenario, the excess amount received above the par value at the time of share issuance is deducted from the Paid-in Capital account.
Example
Based on the given information, XYZ Limited initially had 1,000 shares available in the open market. Each share was issued at a value of $22 and had a par value of $2. After analyzing the market and considering other factors, the company determined that its shares were undervalued. As a result, XYZ Limited decided to repurchase 500 shares at a price of $30 per share. The total value of this repurchase is calculated as follows:
500 shares * $30 per share = $15,000
Therefore, XYZ Limited repurchased 500 shares for a total value of $15,000.
Solution:
Now, in this case,
- Common stock at par value $2 × 1,000 = $2,000
- Additional paid-in capital (APIC) = ($22-$2) × 1,000 = $20,000
The repurchase or buyback will create a contra-equity account:
- Cost method: In this case, XYZ Limited will debit the Treasury Stock account with $15,000 and credit the Cash account with $15,000.
- Par value method: In this case, XYZ Limited will debit the account with the par value amount of $1,000, which is calculated as 500 shares multiplied by the par value per share of $2.
Treasury Stock Journal Entry
Let us understand the journal entries in a case when the entity decides not to issue back these shares and instead retire them permanently.
| Dr | Additional paid-in capital |
| Cr | Treasury stock |
Accounting for Treasury Stock
Apart from the above points, there is one more thing to keep in mind while accounting for treasury stock i.e. in either method, cost or par value method, treasury stock transactions do not impact retained earnings. Most of the time, auditors look for this type of error in the company’s financial statements.
Advantages
- It helps companies keep funds in reserve for future investment purposes such as acquiring, purchasing equipment, etc.
- It helps companies in maintaining controlling interest.
- It helps in boosting the undervalued share price in the market.
- Companies buy back shares to improve financial ratios like return on asset and return on equity.
Limitations
- Treasury stocks do not have voting rights entitlements.
- In case of liquidation, treasury stocks do not receive anything from the net assets remaining,
- Different laws regulate the phenomenon in different companies.
Conclusion
Similar to treasury stocks, which are shares not issued to the general public in the open market, these shares also have an impact on the company’s balance sheet. The method helps maintain the price of the company’s undervalued shares, which generally leads to hostile takeovers from competitors.
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