Treasury Stock

Treasury stocks are the set of shares that the issuing company has repurchased from the company's existing shareholders but are not retired. Thus, they are not considered while calculating the earnings per share or the company's dividends. However, it is vital for treasury stock accounting to reflect them in the financial statements of the company.

These are the shares reacquired by the issuing company from the shareholders but not yet retired by the company. They reduce shareholder equity. Treasury Shares do not represent an investment in the firm. Also, it does not receive a dividend and has no voting rights. These treasury shares are not considered when calculating dividends or earnings per share (EPS).

Treasury stocks, also known as treasury shares or reacquired shares, represent shares of a company's stock that it has repurchased from the open market. Unlike outstanding shares held by investors, treasury stocks are held by the company itself, effectively becoming unissued shares. The decision to repurchase shares often stems from a company's belief that its stock is undervalued or as a strategic move to manipulate its capital structure.

One primary purpose of holding treasury stocks is to reissue them later potentially. This allows companies to raise capital quickly, especially during periods when they perceive their stock to be undervalued. Additionally, repurchasing shares can be a strategic method to distribute excess cash to shareholders, signaling confidence in the company's financial health.

However, while the treasury stock method offers strategic advantages, they also come with certain drawbacks. Holding a significant amount of treasury stocks can impact a company's earnings per share (EPS) calculation, potentially inflating the ratio. Additionally, large-scale stock repurchases can lead to reduced liquidity in the market for that particular stock.

Companies need to carefully consider the implications of holding treasury stocks, balancing the potential benefits of reissuing them for capital gains against the impact on financial metrics and market dynamics. Disclosure of treasury stock activities in financial statements is crucial for transparency and providing investors with a clear understanding of the company's capital structure.

The formula for treasury stock accounting is relatively straightforward and involves the cost of repurchasing shares from the open market. It is calculated by multiplying the number of repurchased shares by the average cost per share. Mathematically, it can be expressed as follows:

Treasury Stock = Number of Repurchased Shares x Average Cost per Share.

The company reports treasury Shares accounting at the end of the line items within the equity section. It is listed on the balance sheet as a negative number under shareholders' equity. When the company repurchases the stock, it records the expenditure due to repurchase in a contra-equity account. Thus, the direct effect of writing a treasury stock transaction is a reduction in the total amount of equity recorded on the balance sheet.

The two methods of accounting for treasury stock are the cost method and the par value method. In the cost method, the paid-in capital account is reduced in the balance sheet when treasury shares are purchased. Under the par value method during repurchase, the books will record it as the retirement of shares. Thereby, common stock debits and treasury stock credits. But in both methods, the transactions can’t increase the amount of retained earnings.

Now that we understand the basics and intricacies of the concept, let us explore the practical application through the examples below.

Examples #1

  Let us assume that Company ABC decides to reacquire some of its shares since these are currently undervalued in the open market. When Company ABC buys these shares back, then they become Treasury Stock. It must be kept in mind that if Company ABC decides to resell these, then the profit or losses are not recognized in the income statement of the company.

Suppose Company ABC has excess cash and sees that its stock in the market is trading below its intrinsic value. So it decides to buy back 1,000 shares of its stock at $60 for a total value of $60,000. The total sum of the company’s equity accounts, including common stock and retained earnings, is $1, 20,000. This repurchase of the stocks leads to a contra account. The $60,000 repurchase is deducted from the $1,20,000 equity account balance, leaving a difference of $60,000. Similarly, the cash account on the asset side of the balance sheet decreases by $60,000.

Example #2

source: Colgate SEC Filings

We note from above that Colgate has been buying back shares each year.

• In 2014, Colgate bought back 23,131,081 shares. Due to share s issued for stock options and shares issued for restricted stock units, the balance of treasury stocks at the end of 2014 was 558,994,215 shares.
• Likewise, in 2015, Colgate bought back 22,802,784 shares, and in 2016, Colgate bought back 19,271,304 treasury shares.

There are numerous reasons behind the buyback of issued shares from the open market and the investors. Some of the reasons are listed below:

• Reselling Purpose - They are often kept aside as reserved stock to raise finances or for future investments. A company may utilize the treasury stock to acquire a competing company.
• For controlling interest - Due to buying back of stock, the number of outstanding shares in the open market is reduced, which leads to an increment in the value of the remaining shareholders' interest in the company. With the help of repurchasing, the company management can avoid sudden takeovers in case of failed acquisitions.
• Undervaluation - In some cases, the company's stock may be underpriced in the open market when the market is performing poorly. Buying back the stock usually pushes the share price positively, and the remaining shareholders eventually benefit.
• Retiring of Shares - If the treasury shares are labeled as retired, then they cannot be sold and are removed from the market circulation. It leads to a permanent reduction, thus forcing the remaining shares in the open market to serve as a larger percentage of the shareholders' ownership.
• Reducing the cost of capital - Shareholders lend capital to a company for its operations and expansion when it cannot generate more than the cost of equity in terms of return using that fund. The company is not making any economic profit. In that case, it is preferable to return some portion of the shareholder's fund and reduce the percentage of shareholding. It will help in reducing the cost of capital for the company and increase its value.
• Improvement of financial ratios - If the company has a positive reason for reacquiring stocks, then as an aftermath, the financial ration will improve. It, in turn, leads to an increase in return on assets (ROA) and return on equity (ROE) ratios. These ratios give a clear understanding of the positive company market performance.

Let us understand the distinctions between the treasury stock method and capital stock through the comparative points below.

Treasury Stock

• Treasury stock refers to shares of a company's own stock that have been repurchased from the open market and are held by the company itself.
• These shares are no longer outstanding and do not carry voting rights or receive dividends.
• Often repurchased when a company perceives its stock as undervalued or as part of a strategic move to manipulate its capital structure.
• Recorded as a contra-equity account on the balance sheet, reducing shareholders' equity.

Capital Stock

• Capital stock represents the total shares that a company is authorized to issue, including both outstanding shares held by investors and any treasury stock.
• Encompasses all classes of shares, including common and preferred shares, that constitute the ownership of the company.
• It serves as a means for the company to raise capital by issuing shares to investors.
• Appears in the shareholders' equity section of the balance sheet, reflecting the total ownership interest in the company.

To understand the concept of the treasury stock method better, it is vital to understand the differences between similar methods. Let us do so through the comparative table below.

This article has been a guide to what Treasury Stock is. Here we discuss treasury stocks in the balance sheet and its accounting, along with practical examples. We also discuss the differences between treasury and outstanding shares and why a company goes for buybacks. You can learn more about Corporate Finance here –

• Treasury Stock Method
• Stock Options vs RSU Differences
• Right Issue vs Bonus Issue
• Stocks vs Shares