Treasury stock refers to the stock a company repurchases and holds in its treasury. Though it may seem counterproductive, companies may repurchase shares to increase shareholder value.
Offering shares to the public is an effective way for a company to raise capital, and every company selling stock on the open market is authorized to sell a set amount of company shares. Of this amount, the total number of shares owned by investors is known as the shares outstanding. On the other hand, the total number of shares available to the public is known as the float.
At times, a company may want to reign in the number of shares on the open market to increase stock price, avoid a hostile takeover, or get cash into shareholders’ hands in a tax-advantaged way. They can accomplish this by repurchasing shares. When a company obtains its own stock — called a stock repurchase or stock buyback — these shares are known as treasury stocks. Keep reading to learn more about treasury stock, why a company may want to repurchase stock, and how to include treasury stock on account balance sheets.
What is treasury stock?
Treasury stock (also called treasury shares) is reacquired stock that a company has bought back and holds in its treasury. This can happen at a couple of different times:
- The issuing company buys back outstanding shares currently on the stock market.
- The issuing company has some remaining outstanding shares that didn’t sell and bought back the unsold stock.
Keep in mind that a company buying back its own stock is different from a corporation retiring shares outstanding.
How does treasury stock work?
Treasury stock is a contra-equity account recorded in the shareholders’ equity section of the balance sheet. In the general ledger account, there will be a negative balance equal to the cost of the shares repurchased by the company.
Treasury stocks reduce shareholders’ equity by the amount paid for the stock since these were repurchased from the open market. Because of this, the cost of treasury stock reduces the corporation’s cash and the total amount of stockholders’ equity.
A company can decide to retire treasury stocks or hold them for resale in the open market later. When shares are retired, these cannot be reissued. Retired shares are thereby no longer listed as treasury stock on the company’s financial statements.
Because of possessing excess cash, a company decides to buy back 20,000 of its own shares out of its 300,000 outstanding shares. The market value of the 20,000 shares is $50 per share. The corporation’s entry to record the purchase of these shares are:
- Debit treasury stock of $1,000,000
- Credit cash of $1,000,000
What is the difference between retired and non-retired treasury stock?
Retired treasury stock is permanently retired and cannot be resold on the market at a later date. However, non-retired treasury stock is held by the company in its treasury account. These stocks can be reissued at a later date as necessary. Non-retired stocks can be traded again on the open markets as:
- Dividends to equity shareholders
- Shares issued per options agreements (or related securities)
- Stock-based compensation to employees
- Capital raising
If you don’t want to raise capital by trading treasury stock on the market, you may be able to get the capital you need from a business loan instead.
Why would a company want to buy back shares?
There are several reasons why a company might buy back shares. Generally speaking, most firms try to reduce the circulation of stock on the market to boost shareholder value. With fewer shares available for circulation, each share will hypothetically increase in value.
To reduce its supply of outstanding stock, a company may make a tender offer to current shareholders, or a bid to purchase a shareholder’s stock. Since shareholders can reject this offer, the company can also try to purchase shares on the open market.
Let’s say Company A is trading on the market at $60 per share. The company currently has 20 million shares outstanding. Company A then decides to buy back 10 million shares, which are now treasury stock.
When the company’s annual earnings of $30 million aren’t affected by the transaction, the earnings-per-share then increases from $1.50 to $3.00. The remaining shares will (at least temporarily) fetch a higher price than their current market price.
How does stock buyback affect share prices?
Companies decide to buy back their own stock because the current share price is undervalued. If the company’s share price has fallen in recent periods, a buyback can signal to the market that the stocks are potentially undervalued and therefore raise share prices.
Therefore, the company’s excess cash is used to return capital to equity shareholders rather than issuing a dividend. Although this can cause prices to go up in value, if the shares were already priced correctly, the repurchase may not have a financial impact on the stock price. In the end, share prices ultimately become valued according to how the market perceives the repurchase itself.
Why are treasury shares a contra-equity account?
A contra-equity account is a stockholders’ equity account with a negative balance. This means that the account retains a net debit balance. The account, therefore, reduces the total amount of equity a business owns.
Since treasury shares reduce a business’s shareholder’s equity, treasury shares are, therefore, a contra-equity account. This is because treasury stock is shown with a negative value on the balance sheet because treasury stock was repurchased from the open market. The cash flow statement shows share repurchases as a cash outflow or use of cash.
Accounting for treasury stock transactions
If you thought “treasury stock” was an obscure financial term, imagine trying to account for it on a company’s balance sheet. If you have questions about this, please talk to an accountant with experience in stock buybacks. But here’s a primer to get you started.
When a company initially puts shares on the open market, the equity section of the balance sheet increases due to the common stock and additional paid-in capital (APIC) accounts. The common stock account reflects share par values, whereas the APIC account reflects the excess value received over the par value. Because of double-entry bookkeeping, the offset of this entry is a debit, which raises cash (or other assets).
That being said, treasury shares reduce total shareholder equity and are often labeled as treasury stock or equity reduction on the balance sheet. The treasury stock account is debited using the cash method to decrease total shareholders’ equity. The cash account is therefore credited to reflect the expenditure of company cash.
At a later date, if the treasury stock is resold, the cash account is thereby increased with a debit, and the treasury stock account is decreased through a credit while increasing total shareholders’ equity. Additionally, a treasury paid-in capital account is then debited or credited, depending if the stock was resold at a loss or gain.
Methods for accounting treasury stocks
There are two approaches to accounting for treasury stock: the cost method and the par value method.
The cost method
This is the more common approach to account for treasury stock. With this method, the value paid of the treasury stock is listed within the stockholders’ equity portion of the balance sheet. The cost method overlooks the par value of the stock, as well as the amount received from investors when the stock was initially issued.
The par value method
An alternative way to value stock is by using the par value method. Using this method, the shares are valued by their par value when repurchased. The sum is then debited from the treasury stock account, decreasing the shareholders’ equity. The common stock APIC account is thereby debited by the amount originally paid above the par value by the shareholders.
The cash account is then credited with the total cost of the share repurchase. The net amount is included as either a debit or a credit, depending on whether the company paid more or less than the shareholders paid originally.
Whether APIC is credited or debited with the par value method depends on how large the credit is compared to the debit.
- If the credit is less than the debit, APIC is then credited to equalize.
- If the credit is greater than the debit, APIC is debited to equalize.
What is the difference between common stock and treasury stock?
Common stocks are shares that represent partial ownership of a company that accrues dividends, are included in earnings per share calculations, and carry voting rights. On the other hand, treasury stocks are owned by the company itself, do not receive dividends, are not included in earnings per share calculations, and have no voting rights.
Is treasury stock a debit or credit on the company balance sheet?
On the company balance sheet, treasury stock retains a debit (or negative balance) as a contra-equity account.
- Treasury stock is a formerly outstanding stock that was bought back and is now held by the issuing company.
- Companies generally buy back stock to increase shareholders’ value and reduce shareholders’ equity.
- Treasury stock reduces total shareholders’ equity on the company balance sheet, is shown as a negative balance or debit, and is (therefore) a contra-equity account.
- The cost and par value methods are the two accounting methods used to record treasury stock.
View Article Sources
- What are stocks? — U.S. Securities and Exchange Commission
- Earnings Per Share — U.S. Securities and Exchange Commission
- What Is Face Value? Definition and Examples — SuperMoney
- What is a Stock Float? Examples of High Vs. Low — SuperMoney
- How To Invest In The Stock Market: 8 Basic Concepts — SuperMoney
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- How To Invest Your Savings To Build Your Own Startup — SuperMoney
- How To Buy Stocks With a Debit Card — SuperMoney
- What is Par Value in Stocks and Bonds? — SuperMoney
- Interactive Brokers Investor Account — SuperMoney
- Vanguard Brokerage — SuperMoney