How Are Treasury Stock (Treasury Shares) Typically Used on Balance Sheets?
Treasury stock, also known as treasury shares or reacquired stock, plays a unique role in a company's balance sheet. It represents shares of the company's stock that have been bought back from stockholders and are held by the issuing company. In this article, we will delve into the typical uses of treasury stock on balance sheets and explore the methods of recording treasury stock, such as the cost method and the par value method.
Understanding Treasury Stock
Treasury stock is recorded as a contra-equity account within the shareholders' equity section of a company's balance sheet. It is essentially a representation of the number of shares repurchased from the open market, and it reduces shareholders' equity by the amount paid for the stock. Treasury stock differs from outstanding shares in that it does not entitle the holder to voting rights, dividends, or inclusion in earnings per share (EPS) calculations.
Treasury stock can be either retired or held for resale in the open market. Retired shares are permanently canceled and cannot be reissued later, while non-retired treasury shares can be reissued through various mechanisms, such as stock dividends, employee compensation, or capital raising.
Recording Treasury Stock
Recording treasury stock on the balance sheet involves the use of two main methods: the cost method and the par value method. These methods determine how the value of treasury stock is accounted for and how it affects shareholders' equity.
- Cost Method:
Under the cost method, the value paid by the company during the repurchase of shares is used, and the par value is typically ignored. The cost of the treasury stock is included within the stockholders' equity portion of the balance sheet. This method is commonly used when stocks have minimal par values, such as $1, but are bought and repurchased for significantly more.
When using the cost method, the treasury stock account is debited at the time of the share repurchase to decrease total shareholders' equity. The cash account is credited to reflect the expenditure of company cash. If the treasury stock is later resold, the cash account is increased through a debit, and the treasury stock account is decreased through a credit. Furthermore, a treasury paid-in capital account may be debited or credited, depending on whether the stock was resold at a loss or a gain.
- Par Value Method:
The par value method values the stock acquired in a buyback according to the par value at the time of repurchase. This amount is debited from the treasury stock account to decrease total shareholders' equity. The common stock APIC (Additional Paid-In Capital) account is also debited to account for the amount originally paid in excess of par value by the shareholders. Simultaneously, the cash account is credited with the total cost of the share repurchase. The net amount is recorded as either a debit or a credit, depending on whether the company paid more or less than the shareholders did originally.
Example of Treasury Stock
To illustrate these methods, let's consider an example with ABC Company. ABC Company initially sold 5,000 shares of common stock with a $1 par value for $41 per share. This resulted in $5,000 in common stock and $200,000 in common stock APIC on its balance sheet. ABC Company decided to repurchase 1,000 shares of its stock at $50 per share, totaling $50,000.
Using the cost method, the treasury stock account is debited for $50,000, and cash is credited for the same amount. In the par value method, the treasury stock is debited for $1,000 (1,000 shares x $1 par value), common stock APIC is debited for $49,000 (1,000 shares x ($50 repurchase price – $1 par value)), and cash is credited for $50,000.
Both methods decrease the total shareholders' equity by $50,000, bringing ABC Company's equity accounts down to $450,000.
Treasury Stock and Retired Shares
Treasury stock can either be retired or held for resale and understanding the difference is crucial. Retired shares are those treasury shares that have been repurchased by the issuer out of the company's retained earnings and are permanently canceled. These shares cannot be reissued, have no market value, and no longer represent ownership in the issuing corporation. As a result, retired shares are not listed as treasury stock on a company's financial statements.
Treasury stock plays a significant role in a company's balance sheet. It represents shares that have been bought back from stockholders and are held by the issuing company. The methods of recording treasury stock, such as the cost method and the par value method, determine how it affects shareholders' equity. Understanding these methods is crucial for financial analysts and investors to assess a company's financial position accurately. Treasury stock allows companies to make strategic financial decisions, such as returning value to shareholders or utilizing excess cash for future investments.
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