Readers will likely agree that understanding concepts like treasury stock is important for making informed investment decisions.
This article clearly explains what treasury stock is, why companies repurchase shares, and how it impacts financial statements and shareholders.
You'll learn the definition of treasury stock, its purpose, the mechanics of stock buybacks, financial reporting implications, strategic reasons for repurchases, and real world examples.By the end, you'll have a solid grasp of this key accounting and investing concept.
Introduction to Treasury Stock in the Stock Market
Treasury stock refers to shares of a company's stock that the company itself has repurchased and holds in its own treasury. This gives the company more control over the outstanding shares in the market.
Understanding Treasury Stock in Accounting
When a company buys back its own shares, those shares are not considered outstanding anymore because they are held by the company itself. However, the shares are still authorized and issued shares. They are just no longer in the hands of investors.
On the company's balance sheet, treasury stock is listed under the shareholders' equity section as a negative number, representing a contra equity account. It decreases the total shareholders' equity. For example, if a company buys back $100,000 worth of shares, the treasury stock account will show -$100,000. This reflects that the transaction reduced shareholders' equity.
The accounting equation balances because the $100,000 cash spent on buying back the shares is no longer an asset, which is offset by the $100,000 decrease in shareholders' equity from treasury stock.
Why Companies Repurchase Outstanding Shares
There are several reasons why a company might decide to repurchase its outstanding shares:
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Increase earnings per share - By reducing the number of outstanding shares, the company's net earnings are divided by a lower number of shares, increasing EPS.
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Return cash to shareholders - Buying back stock allows the company to distribute excess cash to shareholders tax-efficiently.
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Increase shareholder value - Decreasing supply of shares can boost share prices and overall value.
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Prevent hostile takeovers - Large companies will repurchase shares to make takeovers more difficult and expensive by reducing number of shares outstanding.
Treasury Stock as a Contra Equity Account
Treasury stock represents shares that were previously issued but were repurchased by the company. It is recorded in shareholders' equity but as a negative amount, because repurchasing shares represents a reduction in equity.
Specifically, treasury stock is a contra account against other equity accounts like common stock, APIC, and retained earnings. This means that while all the other equity accounts have positive balances, treasury stock has a negative balance that offsets the total.
For example, if a company has:
- Common stock: +$500,000
- APIC: +$200,000
- Retained earnings: +$150,000
- Treasury stock: -$100,000
Its total shareholders' equity would be $750,000. So treasury stock reduces the total equity that belongs to shareholders.
What is treasury stock in simple words?
Treasury stock refers to shares of a company's own stock that it has repurchased from shareholders. Some key points about treasury stock:
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Treasury stock is issued stock that has been bought back by the company. It is not retired or cancelled but held by the company for future use if needed.
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Companies may choose to repurchase their shares for various reasons - to boost stock price, prevent takeovers, use excess cash, or award to employees.
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The repurchased shares continue to exist on the balance sheet but are deducted from shareholders' equity. They no longer count as shares outstanding.
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Treasury shares can be reissued back to stockholders for purchase when companies need to raise cash. The shares may also be retired if not needed anymore.
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Accounting-wise, treasury stock is a contra equity account that reduces total shareholders' equity. The journal entry is to debit treasury stock and credit cash when shares are first repurchased.
In simple terms, treasury stock refers to a company's own shares which it buys back from investors or keeps in reserve. The shares still exist on the books but are not counted as stock outstanding. They can be reissued if the company needs to raise funds. Treasury stock reduces the book value of total shareholders' equity.
What is the purpose of the treasury stock?
Treasury stock serves several key purposes for a company:
Resale
Companies often repurchase their own shares with the intent to resell them later at a higher price, generating a profit. This allows them to take advantage of any future increase in their stock price.
Control
Buying back stock can allow a company to consolidate voting control and prevent hostile takeovers. With fewer shares outstanding, existing shareholders have greater ownership and voting power.
Support Share Price
Large buybacks signals confidence in the company's future and helps provide price support by increasing demand for the shares. This helps prevent undervaluation of the stock.
Improve Financial Ratios
Repurchasing stock reduces the number of shares outstanding, which can boost metrics like earnings per share and return on equity. This makes financial ratios appear more attractive.
The main reason companies buy back stock is to invest in themselves. By repurchasing undervalued shares, they can enhance shareholder value over the long run. It gives management another flexible tool to create value.
What is the difference between stock and treasury stock?
Treasury stock and common stock are two different types of stock that companies issue. The key differences between them are:
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Ownership: Common stock represents ownership in a company and entitles shareholders to voting rights and potentially dividends. Treasury stock are shares that were previously issued but later repurchased by the company itself. The company does not have ownership rights or voting power for treasury shares.
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Voting Rights: Common stockholders have voting rights that allow them to vote on company matters like electing the board of directors. Treasury stock does not have any voting rights.
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Dividends: Common stockholders may receive dividend payments if the company chooses to distribute profits to shareholders. Treasury stock does not receive dividends.
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Accounting Treatment: On the balance sheet, common stock is recorded in shareholders' equity. Treasury stock is recorded as a contra equity account, meaning it has a negative balance that reduces shareholders' equity.
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Purpose: Companies issue common stock to raise funds from public investors. Treasury stock is most often repurchased by companies seeking to boost stock prices, consolidate control, or use excess cash.
In summary, common stock represents ownership interest and treasury stock represents shares repurchased by the company. While common stock has voting rights and may receive dividends, treasury stock does not.
What happens when you purchase treasury stock?
When a company purchases treasury stock, it buys back its own shares that were previously issued to investors. Here are the key things that happen:
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The company's cash reserves are reduced by the amount paid to repurchase the shares. This cash goes directly to the investors selling their stock back to the company.
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The treasury stock purchased is recorded on the company's balance sheet as a contra equity account. It has a negative balance that reduces total shareholders' equity.
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The number of shares outstanding is reduced by the number of treasury shares purchased. However, these treasury shares are not retired unless the company decides to formally cancel them.
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If the treasury shares are formally retired, the number of authorized shares is reduced. The par value of retired treasury shares also reduces the common stock account.
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If not retired, treasury shares can be reissued back to the market later for the possibility of capital gains if the share price has increased.
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Buying back stock can increase earnings per share since fewer shares are outstanding. It also returns cash to shareholders directly through the repurchase.
So in summary, purchasing treasury stock reduces cash reserves, reduces shareholders' equity through the contra account, decreases outstanding shares, and gives the potential to improve EPS metrics. The company can later decide whether to retire the shares or potentially reissue them.
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The Mechanics of Treasury Stock Transactions
Treasury stock refers to shares of a company's own stock that it has repurchased from shareholders. When a company buys back its shares, it records treasury stock as a contra equity account on its balance sheet.
Treasury Stock Journal Entry Examples
Here is an example of the journal entry to record treasury stock:
Treasury Stock $100,000
Cash $100,000
In this example, the company repurchased $100,000 worth of its own shares. The treasury stock account is debited, and cash is credited.
When the treasury shares are retired/cancelled, the following entry is made:
Retained Earnings $100,000
Treasury Stock $100,000
This entry removes the shares from the books by debiting retained earnings.
The Cost Method of Accounting for Treasury Stock
Under the cost method, treasury stock is recorded at the repurchase price of the shares. The account is presented as a deduction from shareholders' equity on the balance sheet.
For example, if a company buys back $100,000 of stock, treasury stock will be debited for $100,000. Shareholders' equity decreases by the same amount. There is no gain or loss recorded under the cost method.
Par Value and Additional Paid-in Capital Adjustments
When treasury stock is purchased, consideration must be given to par value and additional paid-in capital accounts.
If the shares are repurchased above par value, the difference is deducted from additional paid-in capital. If additional paid-in capital does not have enough to cover the amount paid above par, the remainder is deducted from retained earnings.
Conversely, if shares are bought back below par value, the difference is added to additional paid-in capital.
Proper accounting for par value and additional paid-in capital prevents these accounts from becoming negative balances on the balance sheet.
Financial Statement Implications of Treasury Stock
Treasury stock refers to a company's own shares that it has repurchased from shareholders. When a company buys back its own outstanding shares, this can influence the company's financial statements in several ways:
Treasury Stock Balance Sheet Deduction
When a company repurchases its own shares, these shares are not considered outstanding anymore. Instead, they become treasury shares owned by the company itself.
On the balance sheet, treasury stock is deducted from shareholders' equity. More specifically, it is deducted from the company's total paid-in capital and retained earnings balances. This directly reduces total shareholders' equity on the balance sheet.
For example, if a company repurchases $1 million worth of its own common stock, its balance sheet equity section would show a $1 million deduction from paid-in capital and/or retained earnings. The treasury stock account would show a $1 million balance representing the value of shares the company now owns itself.
This means that buying back stock does not affect a company's total assets or operating performance. However, it does reduce balances available for paying dividends or reinvesting in growth.
Effects on Earnings-per-Share and Dividend Payments
When a company buys back its shares, the number of outstanding shares in the market is reduced. Assuming net income stays constant, this increases earnings per outstanding share.
For example, if a company earns $1 million in net income and has 100,000 shares outstanding, EPS is $10 per share ($1 million / 100,000 shares). If the company buys back and cancels 10,000 of those shares, net income is still $1 million but is now divided over only 90,000 outstanding shares, making EPS $11.11 per share.
In theory, higher EPS can make the company's stock more attractive to investors. However, buying back shares also reduces cash reserves, limiting funds available for paying cash dividends. Companies must balance these tradeoffs carefully when deciding to repurchase stock.
Impact on Cash and Retained Earnings
When a company buys treasury shares, it spends cash upfront to repurchase the stock. This directly reduces cash and cash equivalents on the balance sheet. It also lowers retained earnings depending on whether the shares are retired or held for reissue.
If shares are retired permanently, both cash reserves and retained earnings are decreased by the full repurchase price. However, if shares are held as treasury stock for potential reissue, only cash is reduced initially. Retained earnings are lowered incrementally if and when the shares are later retired.
In summary, repurchasing stock directly impacts a company's cash balances, equity accounts, outstanding share count, and key per-share performance metrics. Careful financial analysis is required to determine whether buybacks are in shareholders' best interests.
Strategic Reasons for Stock Buybacks
Companies may repurchase their own outstanding shares for several strategic reasons related to enhancing shareholder value and defending against threats.
Boosting Shareholder Value Through Buybacks
Stock buybacks can increase shareholder value in a few key ways:
- Influencing market price: By reducing the number of outstanding shares, buybacks can artificially increase metrics like earnings-per-share. This can send positive signals to investors and boost the company's market price and valuation.
- Unlocking capital gains: Buybacks enable shareholders to realize capital gains by selling their appreciated shares back to the company, often at a premium price. This provides a tax-advantaged way to return value.
- Alternative to dividends: Rather than issuing cash dividends, buybacks let investors choose whether to receive returns on their investment. Investors who don't sell can benefit from capital appreciation.
Overall, strategically-timed buybacks that take advantage of undervalued share prices are an effective way for management to increase returns for continuing shareholders.
Preventing Hostile Takeovers with Treasury Stock
Companies can also use share repurchases to reduce the availability of voting shares as a defensive tactic against hostile takeovers:
- By decreasing the number of voting shares outstanding, buybacks allow management to consolidate voting power and gain more control over the company.
- Treasury stock also reduces the number of shares that could be acquired by outside investors or acquirers during a hostile takeover attempt.
- Overall, maintaining treasury shares enhances management's ability to resist unwanted acquisition bids and proxy fights by concentrating voting power.
Utilizing Stock Buybacks for Stock Options
Many companies also repurchase shares to fulfill employee stock option plans:
- Stock options are commonly used as incentive-based compensation for executives and employees.
- But issuing large amounts of new shares to meet stock option obligations can dilute shareholder value.
- Instead, companies may buy back stock to build up treasury shares that can be used to fulfill stock option exercises without dilution.
- This allows companies to incentivize employees while avoiding the negative effects of share dilution.
In summary, companies strategically repurchase stock to increase shareholder value, defend against corporate takeovers, and meet obligations under stock option plans. When executed properly and timed well, stock buybacks can be an effective financial maneuver.
Treasury Stock: Authorized, Issued, and Outstanding Shares
Differentiating Between Types of Shares
Authorized shares refer to the maximum number of shares a company is legally permitted to issue, as specified in the company's articles of incorporation. Issued shares are those that the company has actually sold or issued to shareholders. Outstanding shares are issued shares that are currently held by shareholders and have not been repurchased or retired by the company.
Treasury stock refers to shares that were previously issued but have since been repurchased by the company. Treasury stocks are considered issued shares but not outstanding shares.
The Role of Treasury Stock in Share Count
When a company issues new shares, this increases the number of shares issued and shares outstanding. However, when a company repurchases its own shares, these shares become treasury stock.
Although treasury stock is technically still issued shares, they are not considered outstanding shares since they are held by the company itself. So while issuing new shares increases issued and outstanding shares, share repurchases decrease only outstanding shares.
Retired Shares Versus Treasury Stock
Unlike treasury stock which is held by the company for potential reissuance, retired shares are shares the company has repurchased and formally removed from the books. Retired shares decrease the number of shares issued, whereas treasury stock only decreases shares outstanding.
Retiring repurchased shares also reduces the company's authorized shares, since retired shares can no longer be reissued. Treasury stock, on the other hand, has no impact on authorized shares since the repurchased shares could theoretically return to the market.
Real-World Examples of Treasury Stock Transactions
Treasury stock refers to a company's own repurchased shares that are being held by the company. Here are some real-world examples and case studies that demonstrate how companies strategically utilize treasury stock transactions:
Case Study: A Major Buyback Initiative
In 2018, Apple announced a $100 billion stock buyback plan over two years. This represented one of the largest corporate stock repurchases ever.
- Apple funded this initiative through domestic cash as well as debt offerings. The buybacks aimed to reduce share count and boost earnings per share.
- Over 2018-2019, Apple repurchased over $80 billion worth of its shares. This led to a reduction of approximately 15% in Apple's total outstanding shares.
- Analysts credited the buyback program as one factor that supported a 50% increase in Apple's stock price during this period. The reduced share count amplified the impact of Apple's strong earnings growth on its stock valuation.
This case illustrates how large stock repurchases, if properly executed, can benefit shareholders through stock price appreciation and increased earnings per share. The buybacks also allowed Apple to productively deploy its massive cash reserves.
Example: Treasury Stock and Tender Offers
In a tender offer, a company offers to repurchase shares directly from shareholders at a specified price. This differs from open market buybacks.
- In 2021, software company Intuit announced a tender offer to repurchase $2 billion worth of its common shares, at a price of $580 per share.
- This represented a 15% premium over Intuit's market price at the time. The tender offer aimed to return capital to shareholders and minimize dilution from employee stock awards.
- Intuit ended up repurchasing 3.45 million shares through the tender process. These shares were held as treasury stock.
- On Intuit's balance sheet, the $2 billion used to buy back shares was deducted from shareholders' equity. The treasury stock was recorded as a negative balance sheet equity account.
This example shows how tender offers directly target shareholders in an effort to boost stock price and enhance shareholder returns through share repurchases. The accounting entries follow typical treasury stock treatment.
Conclusion: Summarizing Treasury Stock Concepts
Key Takeaways on Treasury Stock
Treasury stock refers to shares of a company's stock that have been repurchased by the company. Some key points about treasury stock:
- Treasury stock is considered issued but not outstanding stock. It is not included in the calculation of earnings per share or dividends.
- Repurchasing treasury stock decreases the number of shares outstanding and the balance in shareholders' equity.
- Companies may repurchase shares to boost share price, consolidate ownership, or use excess cash. There are also tax benefits.
- On the balance sheet, treasury stock is a contra equity account that reduces shareholders' equity. It appears as a negative asset.
The Strategic Value of Stock Repurchases
Companies may choose to repurchase their outstanding stock for several strategic reasons:
- Increasing share price - By reducing shares outstanding, repurchases can boost earnings per share and returns for remaining shareholders. This often increases share price.
- Tax benefits - Capital gains from selling back shares to the company can be more tax-efficient than dividends.
- Consolidating ownership - Large stock buybacks allow founders and executives to increase their ownership share.
- Excess cash - Rather than letting cash sit unused on the balance sheet, companies can create shareholder value by repurchasing stock.
However, large buybacks can also be controversial if they come at the expense of long-term investments and innovation. Overall, treasury stock allows companies financial flexibility, but the repurchases should align with strategic goals.
