What Is Treasury Stock?

What Is Treasury Stock?

Let me explain treasury stock directly to you: it's previously outstanding stock that a company buys back from its stockholders. This action decreases the total number of outstanding shares available on the open market. These shares stay issued but don't count toward dividend distributions or earnings per share (EPS) calculations. You might also hear it called treasury shares or reacquired stock.

Key Takeaways

Treasury stock is formerly outstanding stock repurchased and held by the issuing company. It acts as a contra equity account, reducing total shareholders' equity on the balance sheet. You should know there are two main methods for recording it: the cost method and the par value method.

Understanding Treasury Stock

Treasury stock appears as a contra equity account in the shareholders' equity section of the balance sheet. It represents shares repurchased from the open market, and it reduces shareholders' equity by the amount paid for those shares. Besides skipping dividends and EPS inclusion, these shares carry no voting rights. Regulatory bodies, like the SEC in the United States, may limit how much treasury stock a company can repurchase.

You can retire treasury stock or hold it for resale. Retired shares get permanently canceled and can't be reissued; they vanish from the financial statements as treasury stock. Non-retired shares might reappear through stock dividends, employee compensation, or to raise capital.

Important Ways Companies Reacquire Shares

Companies reacquire shares through methods like tender offers or direct repurchases. In a tender offer, they buy back shares from investors at a premium above market price. For direct repurchases, they buy on the secondary market just like any investor would.

How Treasury Stock Is Recorded

When a company first issues stock, it credits the equity section of the balance sheet to common stock and additional paid-in capital (APIC) accounts. Common stock covers the par value, while APIC handles the excess over par. Double-entry bookkeeping debits cash or another asset for the amount received.

Treasury shares reduce total shareholders' equity and get labeled as treasury stock or equity reduction. The two accounting methods are the cost method and the par value method.

Cost Method

The cost method, used by most public companies, records treasury stock based on the repurchase price, ignoring par value. This cost goes into the stockholders' equity section. Stocks often have a low par value like $1 but get repurchased at higher prices.

On repurchase, debit the treasury stock account to decrease equity and credit cash for the expenditure. If resold, debit cash to increase it, credit to decrease treasury stock, boosting equity. A treasury paid-in capital account gets debited or credited based on loss or gain from resale.

Par Value Method

In the par value method, debit treasury stock at the par value of repurchased shares to decrease equity. Also debit the common stock APIC by the original amount paid over par. Credit cash for the total repurchase cost. The net goes as a debit or credit to the treasury APIC account, depending on whether the company paid more than shareholders originally did.

The Scale of Buybacks

Corporations use buybacks to cut circulating shares and boost stock prices. In 2023, the top 500 companies spent nearly $795 billion repurchasing their shares.

Purpose of Treasury Stock

Why do companies buy back stock? One reason is to resell them later and raise capital for growth and investments. Another is to increase shareholder interest by reducing outstanding shares, which boosts value and can deter hostile takeovers. Finally, retiring shares increases existing shareholders' ownership stake by removing them from circulation.

Example of Treasury Stock

Consider this hypothetical: ABC Company sold 5,000 shares of common stock with $1 par value at $41 each. On the balance sheet, that's $5,000 in common stock and $200,000 in APIC. With excess cash and belief in undervaluation, they repurchase 1,000 shares at $50 each, totaling $50,000.

Under the cost method, debit treasury stock $50,000 and credit cash $50,000. Under par value, debit treasury stock $1,000, debit common stock APIC $49,000, and credit cash $50,000. In both cases, total equity drops by $50,000—from $500,000 to $450,000, assuming that was the pre-buyback total including retained earnings.

What Are Retired Shares?

Retired shares are treasury shares repurchased from retained earnings and permanently canceled. They can't be reissued or sold, have no market value, and don't represent ownership anymore. You won't see them listed as treasury stock on financial statements.

What Is the Cost Method of Accounting for Treasury Stock?

The cost method values treasury stock at the repurchase price, not par value. It lists this cost in the stockholders' equity section of the balance sheet.

What Is the Par Value Method of Accounting for Treasury Stock?

The par value method values repurchased shares at their par value. Debit treasury stock to reduce equity, debit common stock APIC for the excess originally paid, and credit cash for the total cost. The net is recorded as a debit or credit depending on the price comparison.

The Bottom Line

Treasury stock means shares a company buys back, reducing outstanding shares. They acquire it via tender offers or direct repurchases. Companies hold it to resell for capital, enhance shareholder interests, or retire it. If you want to find a company's treasury stock, check the shareholders' equity section of its balance sheet.