How to Accoun for Stock Repurchase and Financial Accounting

To account for stock repurchase in financial accounting, it's essential to understand the two main methods: the Treasury Stock method and the Cost method.

The Treasury Stock method is the most common approach, where the repurchased shares are recorded as a reduction in retained earnings and an increase in treasury stock.

When a company repurchases its own shares, it can either hold them in treasury or retire them, which means canceling the shares.

Retiring shares reduces the number of outstanding shares, but it doesn't necessarily reduce the company's debt or liabilities.

A stock buyback is when a company decides to repurchase its own previously issued shares either directly in the open markets or via a tender offer.

The total dollar figure a company will spend buying back its own stock is usually specified, but not the number of shares it plans to buy back. This is because the company wants to account for the unpredictability of price action in the open market.

A company may announce a share repurchase program to gauge market conditions and decide whether the stock price on any particular day is in the target range of what they will pay.

For example, Wells Fargo announced a new $30 billion share repurchase program in mid-2023.

The company buys the shares, cancels them, and reduces the total number of shares outstanding. It then announces how many shares were bought and the average price paid at the end of the quarter.

A company buys back shares to sterilize the normal growth in share growth, to effect a change in the stock price, or to return capital to investors in a tax-efficient way.

Here are three reasons why a company might buy back its own stock:

A stock buyback reduces the total number of shares outstanding and can increase earnings per share, but it doesn't create real value for the company.

Here's a summary of the benefits of a stock buyback:

A company announces a share repurchase program, specifying the total dollar figure it will spend buying back its own stock in the market. This means dealing with willing shareholders selling their stock in the company through open market operations.

The company usually doesn't announce the number of shares it plans to buy back, as it's hard to predict the price action in the open market. Instead, it gives a dollar amount to gauge market conditions and decide whether the stock price on any particular day is in the target range.

A stock buyback is a corporate event where a company buys back shares it previously issued to the public and traded in the open markets. Once a company repurchases a portion of its shares, the total number of shares outstanding is reduced.

The share price impact of a buyback should be neutral, as the share count reduction is offset by the decline in cash and equity value. However, the market's perception of the decision can affect the company's valuation, either positively or negatively.

Here's a breakdown of how a stock buyback works:

A company buys back shares for several reasons, including sterilization, leverage, and efficient return. Sterilization involves cancelling shares that would otherwise be issued to employees. Leverage involves using share buybacks to change the stock price by reducing the number of shares outstanding. Efficient return involves returning capital to investors through share buybacks, which can increase dividends per share without increasing the cost of dividends.

A stock buyback can benefit a company's shareholders by increasing earnings per share and the implied share price. However, the real value of the company's fundamentals remains unchanged post-buyback. The company's optimism about its future prospects can pay off handsomely over time, as seen in the S&P 500 Buyback Index, which measures the performance of companies with the highest buyback ratio.

There are different types of stock buybacks, and understanding them is crucial for accounting for repurchased stock. One type of buyback is sterilization, where a company buys back its own shares to cancel out the increase in share growth caused by employee stock options or restricted stock rewards.

Sterilization is often used to maintain a stable number of shares outstanding. Another type of buyback is leverage, where a company uses share buybacks to increase its stock price by reducing the number of shares outstanding, thereby increasing earnings per share (EPS).

Leverage can also be used to create a natural buyer in the market, keeping the price elevated. There are also special or expanded buybacks that investors should watch for, as they can indicate a company's confidence in its future prospects.

Some companies, like those in the S&P 500 Dividend Aristocrats, use buybacks as a way to return capital to investors in a tax-efficient manner. This can lead to an increase in dividends per share without increasing the cost of dividends to the company.

A stock buyback, or share repurchase, is a corporate event where a company buys back its own shares from the public market. This reduces the total number of shares outstanding and can have a positive impact on the share price.

One of the main differences between a stock buyback and a dividend is that a buyback reduces dilution of ownership, whereas a dividend issuance distributes cash directly to shareholders.

Companies prefer share buybacks over dividends because they avoid the double taxation associated with dividend payments. Dividends are taxed twice: once at the corporate level and again at the shareholder level.

Many companies also use stock-based compensation to pay employees, and buybacks can counteract the dilutive impact of these securities.

A share buyback can be a one-time event, whereas dividends are rarely cut unless deemed necessary.

The market tends to assume the worst and expects future earnings to decrease if a long-term dividend program is abruptly cut, causing a sharp decline in share price.

For example, Apple has led all companies in the S&P 500 in the amount spent on share buybacks, with $85.5 billion spent in 2021.

In contrast, dividends are often seen as a sign of a mature company with fewer investments to put its earnings to use.

A share buyback can be a more optimistic signal to the market regarding future growth prospects, as seen in high-growth companies in the tech sector.

The S&P 500 Buyback Index measures the performance of the 100 companies in the index with the highest buyback ratio, and it has had an annual return of 33.65% since its launch in January 1994.

This outperformance can be attributed to the fact that a share repurchase indicates a company's confidence in its future prospects and its belief that its stock is undervalued.

Here's a comparison of the S&P 500 Buyback Index with other indices:

Note that the S&P 500 Buyback Index has had a lower annual return compared to the other two indices, but it's still a notable performer.

A share buyback can have a significant impact on a company's outstanding shares. By cancelling shares, a company reduces its total number of shares, which can affect its per-share measures of profitability and cash flow.

The IFRS does not provide specific guidance on accounting for share repurchases, but ASPE does provide a set of steps to apply when shares are repurchased or cancelled. This involves allocating the acquisition cost in a specific sequence.

The acquisition cost is allocated first to reduce the retained earnings balance, and then to increase the contributed surplus. If the acquisition cost is greater than the assigned value, the excess amount is charged to retained earnings.

For example, if a company repurchases 8,000 shares at a cost of $8 per share, the journal entry would be to eliminate the common shares at their average cost, and to calculate the contributed surplus as the excess amount being charged to retained earnings.

The common shares are eliminated at their new average cost, and the previous contributed surplus is fully utilized, with an additional excess amount being charged to retained earnings.

Here's a summary of the steps to apply when shares are repurchased or cancelled:

A share repurchase can have a significant impact on a company's financials. It reduces the outstanding shares, which can lead to an increase in earnings per share (EPS). This is because the same amount of earnings is now being divided among fewer shares.

The share repurchase can also affect other financial statements, such as the balance sheet. The company's cash holdings and total asset base will decrease by the amount of cash expended in the buyback, while shareholders' equity will also decrease by the same amount.

The impact on return on assets (ROA) and return on equity (ROE) is typically positive subsequent to a share buyback. This is because the denominator (total assets or shareholders' equity) is smaller, making the calculation more favorable.

Here are some key effects of a share repurchase on a company's financials:

The Cost Method is a straightforward way to account for repurchased shares. You simply debit the treasury stock account for the amount paid to buy back the shares.

To repurchase shares, you'll need to determine the number of shares you want to buy back, and then pay out the corresponding cash amount. For example, if you buy back 10,000 shares at $15 per share, you'll pay out $150,000 in cash.

The transaction is recorded in the treasury stock account, with a debit for the amount paid and a credit for the same amount in cash. This is a simple and common practice for many companies.

If you choose to resell the shares, you'll list the resale as a cash debit for the sale amount, plus a credit for any additional paid-in capital in the treasury stock account. This is a key consideration when deciding what to do with the repurchased shares.

Here's a summary of the key steps involved in the Cost Method:

Retiring the shares requires a different approach, with a debit to the treasury stock account for the par value of the common stock.

A share repurchase can have a significant impact on a company's financials, particularly in terms of earnings per share (EPS) and cash flow per share (CFPS). By reducing the number of outstanding shares, a share repurchase can increase EPS and CFPS, assuming the price-earnings (P/E) multiple remains the same.

For example, consider a company like Birdbaths and Beyond (BB), which had 100 million shares outstanding and a market capitalization of $1 billion. After repurchasing 10 million shares, BB's EPS increased to $0.56 from $0.50, resulting in a 12% stock appreciation.

On the balance sheet, a share repurchase reduces a company's cash holdings and total asset base by the amount of cash expended in the buyback, while simultaneously shrinking shareholders' equity by the same amount. This can lead to improved performance metrics such as return on assets (ROA) and return on equity (ROE).

In fact, companies that engage in share repurchases often see an increase in their EPS and CFPS, which can lead to a higher share price. According to the S&P 500 Buyback Index, companies that have been aggressively buying back their shares have seen a significant positive impact on their financials.

Here's a summary of the impact of share repurchases on financials:

Overall, a share repurchase can have a positive impact on a company's financials, particularly in terms of EPS and CFPS.