Treasury Stock - Explained
What is Treasury Stock?
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Table of ContentsWhat is Treasury Stock?How is Treasury Stock Reacquired? Limitations of Treasury StockMethods of Accounting for Treasury StockTreasury Stock Example Academic Research on Treasury Stock
What is Treasury Stock?
Treasury stock, also referred to as reacquired stock, is the outstanding stock that the issuing company buys back from its stockholders. Repurchase of treasury stock typically reduces the number of outstanding shares in the open market and allows the issuing company to either resell such stock to the public or retire (cancel) it. Although stock repurchase is regarded as a viable alternative to paying dividends to stockholders, the issuing company will, by convention, never include such shares in the calculation of dividends or earnings per share (EPS).
How is Treasury Stock Reacquired?
The stock repurchase option comes across as a tax-efficient procedure employed by companies to award lump sum cash payments to its shareholders in lieu of a dividend payout. Such repurchased stock is recorded as a negative or a contra account in the shareholders equity column in the balance sheet. The repurchase of a finite number of shares from the shareholders increases the issuers equity while decreasing the equity of the shareholders by an equivalent amount, which is the total price paid for the repurchased stock. A company that increases its treasury stock is often interpreted as considering its shares to be undervalued. This can prove to be beneficial for shareholders because a stock repurchase results in a reduction in the number of outstanding shares, which in turn, improves the EPS of the stock, and gives each shareholder a bigger chunk of the earnings. On the downside, managers sometimes abuse treasury stock to repurchase shares solely to increase ratios.
Limitations of Treasury Stock
There are certain limitations of treasury shares:
- A treasury stock is never included in the calculations of dividend or earnings per share (EPS).
- Treasury stocks have no voting rights.
- Lastly, there are limits to the total number of shares that any company can hold as treasury shares. This is decided by the regulatory body of the country in which the shares originate. Such a limitation safeguards the interests of debt holders from any self-serving activities of the shareholders.
Companies with Treasury stock can choose to retire (cancel) the stock or resell them to the public in the open market. On the other hand, retired shares are permanently canceled, and companies have no option to reissue them. However, it is possible to reissue non-retired treasury shares in the form of stock dividends or employee benefits or simply as a capital raising exercise. The principal motivation behind issuing stock is to raise cash. When shares are issued, they result in a positive balance in both the common stock account as well as the additional paid-in capital (APIC) account in the equity portion of the companys balance sheet. While the common stock account is a general ledger account that records the par value of the companys shares, the APIC account indicates the value of share capital beyond its stated par value.
Methods of Accounting for Treasury Stock
There are two methods that companies usually employ in order to account for treasury stock:
- The Cost Method: This procedure debits the treasury stock account and credits the cash account with the total amount paid for repurchasing the treasury stock. The cost method essentially ignores the par value of shares while recording the purchase of treasury stock.
- The Par Value Method: This procedure debits the treasury stock account with the total par value of shares acquired and credits the cash account with the with the total amount of cash paid for repurchasing the treasury stock. In the event that the amount debited exceeds the amount credited, the difference between the amounts is credited to the additional paid-in capital (APIC) account from treasury stock. Conversely, if the amount credited exceeds the amount debited, the difference is debited to the APIC account from treasury stock. In case the APIC from treasury stock is unavailable or insufficient, the par value method debits the retained earnings account with the remainder of the amount.
Treasury Stock Example
The concept of treasury shares can be explained with the help of the following example: Company C1 believes that its shares are currently undervalued in the market, that is the stock is trading at a level well below its intrinsic value. C1 has access to cash at hand and decides to spend $1 million from this cash reserve to repurchase 10,000 shares of its own stock at the rate of $100 per share. Now C1s equity account balance, i.e the sum total of common stock, APIC, and retained earnings is $2 million. The treasury stock repurchase creates a negative or a contra equity account in the shareholders equity column in the balance sheet. Therefore, an amount equivalent to the $1 million treasury stock repurchase will have to be deducted from the $2 million equity account balance of C1. This deduction results in an imbalance of $1 million in the balance sheet, which is adjusted by reducing the cash account on the asset side of the balance sheet by an equivalent $1 million.
Academic Research on Treasury Stock
- Treasury Stock, Glenn, G. (1929). Virginia Law Review, 625-642. This paper provides a detailed explanation of the concept of treasury stock. The author expresses his approval for a New York court decision that followed the proceedings with respect to a lawsuit filed by a company against one of its former employees. The employee in question refused to sell his portion of company stock back to the company at the end of his employment, thus violating the terms of a stipulated agreement. The court ruled in favor of the former employee.
- Accounting for treasury stock transactions: Prevailing practices and new statutory provisions, Sprouse, R. T. (1959). Columbia Law Review, 59(6), 882-900. This study seeks to elucidate the extent to which current accounting practices pertaining to treasury stock transactions are segregated from statutory law. It also explicates the extent to which such accounting practices are regulated by corporation statutes. The author hopes that his research would convince legislators and accountants alike to adopt methods that would be both logical as well as effective from both points of view.
- The Treasury Stock Method and Conventional Method in Reciprocal Stockholdings-An Amalgamation, Petri, E., & Minch, R. (1974). The Accounting Review, 49(2), 330-341. The authors inspect the conventional treasury stock method in reciprocal stock-holding circumstances and highlight its lack of consistency with a true treasury stock approach. The paper demonstrates that it is in fact the simultaneous equations method that satisfies all the requirements of the aforementioned true treasury stock approach. The authors also acknowledge the existence of auxiliary simultaneous equations methodologies that can be implemented in the case of reciprocal holding problems with good reason.
- Treasury Stock: A Source of Profit or Loss?, Rankin, C. H. (1940). The Accounting Review, 15(1), 71-77. This paper highlights the practical significance of accounting problems surfacing in treasury stock. Over the past, courts have not only displayed a lack of understanding of conventional accounting methodologies and concepts, but have even failed to ascertain the meaning of those accounting terminologies that form part of their decisions. Of all the misconstrued accounting terminologies, it is especially important to mention the topic of treasury stock - an accounting procedure that has caused a massive disparity between theory and practice as far as a judicial interpretation is concerned.
- Using Treasury 'Repurchase' Shares to Stabilize Stock Markets, Sabri, N. (2003). This article seeks to scrutinize the concept of treasury shares, which, as the author describes, is one of the most vital aspects of international corporate law. The author samples data from thirty five markets of both developed as well as emerging economies and performs a thorough analysis of the prevailing corporate laws, research documents as well as stock trading volume for treasury stock repurchases. The study concludes that the world markets are leaning towards the deregulation of treasury shares.
- Stock markets are not what we think they are: the key roles of cross-ownership and corporate treasury stock, Roehner, B. M. (2005). Physica A: Statistical Mechanics and its Applications, 347, 613-625. This paper elaborates three methodologies employed by corporations to influence share prices. They are: The exercise of control by parent/holding companies over other public companies. Using stock buyback programs and stock issuance to manage fluctuations in stock prices. Using mergers and acquisitions to control stock price levels. The author concludes that corporations have been assuming an increasingly direct role in shaping stock markets over the past few decades.
- Accounting for treasury stock, Ray, J. C. (1962). The Accounting Review, 37(4), 753. This paper offers an insight into the concept of treasury stock and the purpose of holding treasury shares. The author seeks to address the problem of accounting recognition that typically only considers the stockholders equity section of the balance sheet. He also reveals that all methodologies used to account for treasury stock do not recognize such outstanding stock within the equity section. The paper proceeds to suggest the following remedial measures: Summarizing the different proposed methodologies of accounting for treasury stock. Scrutinizing the underlying rationale behind each of these methodologies. Performing a detailed evaluation of all proposed methodologies in order to pick the most appropriate one.
- Dealings in treasury stock, Montgomery, R. H. (1938). Journal of Accountancy (pre-1986), 65(000006), 466. This article describes the disparity that exists between accountants and the judiciary in the understanding of accounting procedures. The author draws this conclusion based on the report of a committee set up to peruse the treatment of purchase and sale by a company of its own stock. This report approved the notion that certain transactions that are typically regarded as inconsequential should not be reflected in earned surplus.
- Statutory influence on treasury stock accounting,, Buttimer, H. (1960). The Accounting Review, 35(3), 476. A committee instituted by the American Accounting Association found that statutory requirements were largely controlling treasury stock accounting transactions. Statutory limitations on treasury stock purchases based on corporate surplus is a common phenomenon across several states of the country. This paper starts with a discussion of the process of accounting for the acquisition of treasury stock and proceeds to undermine the rationale behind having a Treasury Stock account. The author also advocates the direct application of charges originating from treasury stock purchases to retained earnings. The paper then conducts a thorough analysis of the various accounting methodologies applied to the treasury stock disposition transactions.
- The Evolution of Accounting for Corporate Treasury Stock in the United States, Rueschhoff, N. G. (1978). Accounting Historians Journal, 5(1), 1-7. This paper conducts a detailed analysis of the evolution of the accounting process for treasury stock from the early 18th century to date. The author explains the various methodologies that have been employed to build funds through the purchase and subsequent sale of treasury stocks. The paper concludes with a scrutiny of the outcomes of the Internal Revenue Act of 1934 and the Security Exchange Act of 1934 vis--vis the handling of treasury stock.