BASICS OF ANALYSIS

Corporations buy shares of their own stock for a variety of reasons, including (1) using them to acquire another corporation, (2) purchasing shares to avoid a hostile takeover of the corporation, (3) reissuing them to employees as compensation, and (4) maintaining a strong market for their stock or demonstrating management confidence in the current price.

TREASURY STOCK

Treasury stock refers to a corporation's reacquired shares, which are comparable to unissued stock in various ways: (1) neither treasury stock nor unissued stock is an asset, (2) neither receives cash dividends nor stock dividends, and (3) Neither of them permits the exercise of voting rights. However, treasury stock differs from unissued stock in one significant way: the corporation can resell treasury stock for less than par without incurring obligation to the buyers, as long as it was initially issued at par or above. Treasury stock acquisitions necessitate ethical attention on the part of management since monies are distributed to individual stockholders rather than all stockholders. Managers must ensure that the acquisition is in the best interests of all stakeholders. Because of these issues, corporations are required to properly report treasury stock transactions.

Purchasing Treasury Stock

Buying treasury stock diminishes the corporation's assets and equity in the same proportion. (We discuss the most generally used technique of accounting for treasury stock, the cost method. Another approach covered in higher courses is the par value method.) Exhibit 13.13 depicts Cyber Corporation's account balances prior to any treasury stock transaction (Cyber has no liabilities).

Assets		Stockholders’ Equity
30,000	Cash	100,000	authorized, issued, and outstanding
95,000	Other assets	25,000	Retained earnings
125,000	Total assets	125,000	Total stockholders’ equity

Cyber then purchases 1,000 of its own shares for $11,500 on May 1, which is recorded as follows.

Credit	Debit	Description	Date
	11,500	Treasury Stock, Common	May 1
11,500		Cash
		Purchased 1,000 treasury shares at $11.50 per share.

This transaction diminishes equity by debiting the Treasury Stock account, which is a counter equity account. Exhibit 13.14 depicts account balances following this transaction.

Assets		Stockholders’ Equity
18,500	Cash	100,000	authorized and issued; 1,000 shares in treasury
95,000	Other assets	25,000 (11,500)	treasury stock purchase Less cost of treasury stock
113,500	Total assets	113,500	Total stockholders’ equity

The acquisition of treasury stock decreases Cyber's cash, total assets, and total equity by $11,500 but has no effect on the balances of the Common Stock or the Retained Earnings accounts. In the equity section, the equity reduction is calculated by subtracting the cost of treasury stock. There are also two disclosures. First, the stock description discloses that 1,000 issued shares have been placed in treasury, leaving just 9,000 shares outstanding. Second, the description for retained profits implies that it is restricted in part.

Reissuing Treasury Stock

Treasury stock can be reissued by selling it at cost, above cost, or below cost.

Selling Treasury Stock at Cost When treasury stock is reissued at cost, the entry is the opposite of the one made to record the acquisition. For example, if Cyber reissues 100 of the treasury shares acquired on May 1 at the same $11.50 per share price on May 21, the entry is

Credit	Debit	Description	Date
	1,150	Cash	May 21
1,150		Treasury Stock, Common
		Received $11.50 per share for 100 treasury shares costing $11.50 per share

Selling Treasury Stock above Cost If treasury stock is sold for more than its cost, the difference is credited to the Paid-In Capital, Treasury Stock account. This account is reported in the shareholders' equity section as a distinct item. There is never a gain reported from the selling of treasury stock. For example, if Cyber gets $12 cash per share on June 3 in exchange for 400 treasury shares worth $11.50 per share, the entry is

Credit	Debit	Description	Date
	4,800	cash	June 3
4,600 200		Treasury Stock, Common Paid-In Capital, Treasury Stock
		Received $12 per share for 400 treasury shares costing $11.50 per share

Selling Treasury Stock below Cost When treasury stock is sold at a loss, the entry used to record the sale is determined by whether the Paid-In Capital, Treasury Stock account has a credit balance. If it has a zero balance, the difference between the cost and the sales price is deducted from Retained Earnings. If the Paid-In Capital, Treasury Stock account has a credit balance, it is debited for the cost excess above the selling price, but not for more than the account balance. When the credit amount in this paid-in capital account is depleted, any leftover difference between the cost and selling price is deducted from Retained Earnings. To illustrate, suppose Cyber sells its remaining 500 shares of treasury stock on July 10 at $10 per share.

reduced by $750 (500 shares *$1.50 per share excess of cost over selling price), as shown in this entry:

Credit	Debit	Description	Date
	5,000 200 550	Cash Paid-In Capital, Treasury Stock Retained Earnings	July 10
5,750		Treasury Stock, Common
		Received $10 per share for 500 treasury shares costing $11.50 per share.

This entry removes the $200 credit amount from the paid-in capital account generated on June 3 and then decreases the Retained Earnings balance by the remaining $550 cost over selling price excess. A company's loss (or gain) from the selling of treasury stock is never reported.

Retiring Stock

A corporation can buy and sell its own shares. Retiring stock decreases the total number of shares issued shares. The same thing as approved and unissued shares is retired stock. Acquisitions and retirements Stock transactions are permitted under state law only provided they do not threaten the interests of others.

Creditors and stockholders When we buy shares for retirement, we eliminate all capital. sums pertaining to the retired shares This occurs if the purchase price exceeds the net amount eliminated.

The excess is deducted from Retained Earnings. If the net amount from all capital accounts is subtracted if the purchase price exceeds the purchase price, the difference is applied to the Paid-In Capital from Retirement of Account for stock. A company’s assets and equity are always reduced by the amount paid for the retiring stock.

Resources : fundamental accounting principles 20th edition (pdf) John J. Wild , Ken W. Shaw Barbara Chiappetta

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