128. Treasury Stock
Recap of the Cost Method
1. At purchase, the treasury stock account (contra-account) is debited for the cost of the purchase 2. At reissuance, the treasury stock account is credited for the cost (using FIFO cost flow assumption unless otherwise stated) 3. If reissuance price is greater than cost, the difference is credited to APIC from treasury stock 4. If reissuance price is less than cost, the difference is debited to APIC from treasury stock UNTIL that APIC account is zero. Any remainder difference is then debited to retained earnings. 5. The treasury stock account is reported at cost purchased as the last item in the owner's equity section.
Recap of the Par Method
1. At purchase, treasury stock is debited for par. - APIC related to common stock is debited as well (removed) since those shares are no longer outstanding 2. If treasury stock price < original stock issue price, the difference is credited to APIC (treasury stock) 3. If treasury stock price > original stock issue price, the difference is debited to APIC (treasury stock) until zero'd out and any remaining excess is finally debited to retained earnings. 4. At reissuance, the treasury stock is credited FOR PAR - APIC (common stock) is also credited for the original difference between issue price and par value
Example: Cost Method
1st entry: Create debit contra account treasury stock and credit cash for the cost purchased. - Outstanding shares decrease by number of shares purchased - Total effect on equity is the amount of cash paid, or a decrease of $700. 2nd entry: Debit cash received on sale (also the total impact on equity again, increase) and remove the corresponding amount from contra account treasury stock at original cost purchased. - The difference between the two is going to be APIC related to treasury stock, which is the excess reissue price over the cost; it is NOT treated as income - APIC is a credit account, so when it's a credit it's a gain on owner's equity and when it's a debit it's a loss
Impact of Treasury Stock on Stockholder's Equity
Treasury stock acquired: Total stockholders' equity decreases by the amount of cash paid Treasury stock reissued: Total stockholders' equity increases by the amount of cash received Note: Treasury stock only affects the individual components of stockholders' equity, not its total amount
Example Cont: Cost Method - FIFO Valuation Method for Reissuing Treasury Stock
Main thing to note here is that in cases where another reissuing occurs but the cost is different, use the FIFO valuation method for credit the contra-account Treasury Stock. - APIC in this case is a debit, so it's a reduction in the APIC treasury account and an overall reduction in owner's equity
Comparison of Cost and Par Methods
Stays the same: 1. Common stock account 2. Shares outstanding 3. Total owner's equity Different: 1. Other Owner Equity accounts, the composition of the accounts will be different between the two methods 2. Treasury stock account balance will be different between cost and par value methods
Quick CPA Exam Tip
CPA Exams in the past have listed a firm's treasury stock in the investment section of the balance sheet in questions calling for the candidate to identify errors. This requires the candidate to recognize that treasury stock is not an asset of the firm. - It is reported as a contra-owner's equity account. These questions are solved by reducing the investment account by the amount recorded as treasury stock and reinstating the treasury stock account as a reduction from total OE.
Starting Data - Will be used for both cost and par examples to follow
Common Stock, $2 Par: $20,000 APIC - Common: $60,000 Retained Earnings: $30,000 ------------------------------------- Total Equity: $110,000
Example: Par Value Method - Reissuing Shares (& Re-Purchase)
Reissuing Stock: Same entries as issuing 50 shares of common stock but simply use treasury stock instead (APIC still related to common stock) 1. Debit cash for amount received 2. Credit treasury stock AT PAR VALUE * the number of shares being issued 3. Credit the remaining APIC that is related to common stock Repurchasing more shares: 1. Always start with cash, credit cash by $1000 since it's 100 shares repurchased at $10 each. - This is also the total change in equity, a $1000 decrease. 2. Remove treasury stock at par value and remove APIC related to common stock as the remaining difference (issue price - par value) 3. IMPORTANT: The remaining difference will first be attributed to APIC (Treasury) UNTIL that account is zero'd out by the debit. - Then the rest is debited into retained earnings (reduces RE)
Example: Par Value Method - Re-Purchasing Shares
Repurchasing 100 shares: 1. The debit to the treasury stock contra account will be at the original par value of the stocks issued * # of shares repurchased, not at the original issue price. 2. APIC related to common stock will also be reduced by the original amount * # of shares issued (issue price - par value = APIC price per common share) - APIC common stock goes along with treasury stock in par value method 3. Cash is credited as always and represents the net effect on owner's equity (repurchase means decreasing cash and decreasing owner's equity) 4. Final difference is the APIC related to treasury stock, which can be calculated as the difference in repurchase price and issue price * the number of shares repurchased. Takeaways: 1. Common stock itself never changes regardless of cost or par value method 2. HOWEVER, under par value method the APIC related to common stock does get reduced since the treasury stock contra-account is valued at par value. - The extra APIC above par associated with common stock that is repurchased must also be eliminated.
Treasury Stock: Overview
Stock that was issued, but is repurchased by the issuing entity a. NOT an asset or investment b. No votes or dividends associated with treasury stock c. Income is never affected by purchasing treasury stock d. Not included in EPS calculations, therefore EPS is increased (since outstanding shares decrease) e. Retained earnings can be decreased (debit) but not increased (credit) Examples of some reasons for doing so: 1. Stock-based compensation: Firm pays employee in stock, so instead of issuing more stock, they simply rebuy the stock they already issued, putting it into treasury stock 2. Deter hostile takeover attempt: Buy stock back from market to prevent others from being able to buy a controlling interest and take over the company 3. When stock is perceived as undervalued: Management wants to buy stock when its undervalued - When more shares are bought up and there are fewer outstanding shares, the price will naturally go up as well - This also increases earnings per share since the denominator (shares outstanding) decreases when management buys back shares - Can also help make a company more private (less outstanding shares) -> same sentiment as deterring hostile takeover attempts
Example: Par Value Method - Reissuing Shares (Final)
Treat the reissuance as a normal common stock reissuance except use treasury stock instead at par value. - The difference will be APIC attributed to COMMON STOCK 1. Debit cash for amount received, this will always be first step and always the total change in owner's equity for the period (gain in this case since it's a debit to cash) 2. Credit treasury stock at par and APIC (common stock) for the remainder. Under all methods, total value of equity will be the same each period - It is just the components of equity that will be different among these different methods
Accounting for Treasury Stock
Two methods: cost and par value methods 1. Cost Method: Debits treasury stock account at cost 2. Par Method: Debits treasury stock account at par Thus, at reissuance, the treasury stock account is credited for cost or par. Important Note: Common stock is never reduced, treasury stock accounts are simply a contra-account to owner's equity
Example Cont: Cost Method - Average Cost Valuation Method for Reissuing Treasury Stock
Using the average cost assumption, divide the total cost remaining used in acquiring treasury stock by the number of treasury stock shares remaining. In this example, it'd be $350 (50 shares left at $7 cost) + $1000 (100 shares left at $10 cost, just purchased) divided by 150 shares - Resulting average cost is $9, which is used as the cost when doing reissuance accounting Note: When the difference between the debits and credits is larger than the APIC Treasury Stock balance and it would result that account being negative, 'close' the account and put the residual leftover amount as a decrease in retained earnings (as a debit). - This is on the 3rd entry in the picture - This is also the 4th point on the next flashcard Total equity under average cost is same as under FIFO, it's just the underlying components that are different