Tuesday, February 16, 2010

Accounting for Treasury Stock

Hello Dear Reader,
Having addressed on "Earnings per Share", I would like to move on to another essential aspect of stockholder's equity, Accounting for Treasury Stock.

Recalling the definition of Treasury Stock, it is the stock reacquired or repurchased by the issuing entity,  reducing the quantity of outstanding stock on the open market. To explain differently, when an entity reacquires its own common or preferred stock in an open-market transaction, such stock is termed Treasury stock. Bear in mind, it is the stock which is authorized and issued but not outstanding. Also be acquainted that:-
  1. It is reported as a reduction (debit) in stockholder's equity;
  2. No gain or loss is recognized on a treasury stock transaction and
  3. Retained earnings may be decreased abut never increased by the treasury stock transaction.
There are two ways to account for treasury stock transactions:
  • Cost method
  • Par-value method
Either of the methods adopted will not affect the stockholder's equity. What sets them apart is their stance and use of different equity accounts.

Cost Method
It is a less complicated method than the par-value method where an entity considers purchase of treasury stock as a temporary reduction in stockholders equity and not as retirement of shares. Distinguishing features include:
  1. Debit the treasury stock account for the cost to acquire the shares.
  2. At the time of reissuance/sale of treasury stock, credit the treasury stock account for the cost of shares.
  3. The gain/loss on acquistion is recognized at the time reissuance/sale.
    • Gains are credited to paid-in-capital from treasury stock transactions.
    • Losses are first charged to paid-in-capital  from treasury stock transactions and the remainder, if any is charged to retained earnings.
  4. Retirement of treasury stock will require additional journal entries.

Par Value Method
This method holds the view point that a treasury stock transaction is "retirement" of shares and its reissuance/sale is a "new" issue. It is slightly more complex than cost method but when it comes to retirement of treasury stock the journal entries are fairly simple. 

Note: Under par value method we start with the assumption of retiring such shares, therefore, when the treasury shares are actually retired, the treatment is fairly simple. This does not hold true for cost method.

Key features of par value method:-
  1. On repurchase of own shares, debit the treasury stock account for the par value and not the cost of reacquisition.
  2. Treasury shares acquired for a price more than they were originally issuedDebit additional paid-in-capital (APIC - common stock) for the premium received when the shares were first issued to public. The excess, if any, goes to retained-earnings.
  3. Treasury stock acquired at a cost equal to or less than the original issue cost - Debit APIC - common stock for premium at the time of issuance and paid-in-capital from treasury stock is credited for the difference between the original issue price and the cost to acquire treasury stock.
  4. When treasury shares are resold, credit the treasury stock account at par value and credit or debit APIC - Treasury Stock for the remainder.
I have exemplified both the methods through simple transactions in powerpoint slides. Please use the link beneath to view the file.

This brings me to a finale of Treasury Stock Accounting. I trust you benefit from it.

Remain with me...more will come....

Aprajita

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