Understanding How Treasury Stock Affects Stockholders Equity

Treasury stock can significantly impact a company's financial statements, particularly stockholders' equity.

The purchase of treasury stock reduces stockholders' equity by the cost of the shares acquired.

When a company buys back its own shares, it records the transaction as a reduction in stockholders' equity.

This reduction is reflected in the company's balance sheet, which shows a decrease in the par value of the stock.

In the example, Company X purchased 1,000 shares of its own stock for $10 per share, reducing stockholders' equity by $10,000.

Stockholders Equity is an account on a company's balance sheet that consists of share capital plus retained earnings. It represents the residual value of assets minus liabilities, and can be expressed as Stockholders Equity = Assets – Liabilities.

Stockholders Equity provides highly useful information when analyzing financial statements, but debt holders are not very interested in its value beyond the general amount of equity to determine overall solvency.

Shareholders, however, are concerned with both liabilities and equity accounts because stockholders equity can only be paid after bondholders have been paid.

Stockholders Equity is influenced by several components, including Share Capital, Retained Earnings, Net Income & Dividends.

Here are the key components of Stockholders Equity:

Sunny Sunglasses Shop's Shareholders Equity, for example, consists of Common Stock, Additional Paid-In Capital, and Retained Earnings, which total $65,283.

Share Capital refers to amounts received by the reporting company from transactions with shareholders.

Companies can issue either common shares or preferred shares, with common shares representing residual ownership in a company.

Common shares can only receive payments after preferred shareholders have been paid first in the event of liquidation or dividend payments.

If a company issues 10,000 common shares for $50 each, the contributed capital would be equal to $500,000.

The journal entry for this transaction would be a debit to Cash for $500,000 and a credit to Common Shares for $500,000.

Companies can also sell shares on a subscription basis, requiring the buyer to make a down payment and pay the remaining balance at a later date.

For example, if XYZ Company sells 10,000 common shares for $10 each on a subscription basis, the journal entry would be a debit to Cash for $30,000 and a debit to Share Subscriptions Receivable for $70,000, with a credit to Common Shares Subscribed for $100,000.

The share subscriptions receivable functions similarly to accounts receivable, and once the receivable payment is paid in full, the common shares subscribed account is closed and the shares are issued to the purchaser.

Treasury stock is a company's own shares that it has bought back from the market. This can happen when a company thinks its stock is undervalued and wants to buy it back to increase the value per share. The treasury stock account is a contra-equity account that is recorded at cost, which is the price the company paid to acquire the shares.

The treasury stock account reduces the total stockholders equity by the cost of the treasury shares held. For example, if a company has $15,283 in retained earnings and $5,000 in cost of treasury stock held, its total stockholders equity would be $10,283.

A company can reissue treasury stock at a price higher or lower than the original cost. If the treasury stock is reissued at a price higher than the original cost, the company credits a separate contributed capital from treasury stock account. If the company reissues the treasury shares at less than cost, the difference is first taken out of the contributed capital account for treasury shares.

Here are the steps to account for treasury stock transactions:

The company can formally retire the treasury shares by eliminating the treasury stock account and increasing the common stock and contributed capital accounts.

The cost method of accounting for treasury stock treats the purchase of treasury share stock as a temporary reduction in stockholders equity. The capital accounts remain intact as originally reported, since the cost method avoids identifying amounts and prices of original shares issued.