BUS103: Introduction to Financial Accounting

Treasury stock is the corporation's own capital stock that it has issued and then reacquired; this stock has not been canceled and is legally available for reissuance. Because it has been issued, we cannot classify treasury stock as unissued stock.

Recall that when a corporation has additional authorized shares of stock that are to be issued after the date of original issue, in most states the preemptive right requires offering these additional shares first to existing stockholders on a pro rata basis. However, firms may reissue treasury stock without violating the preemptive right provisions of state laws; that is, treasury stock does not have to be offered to current stockholders on a pro rata basis.

Larkin Corporation
Statement of stockholders' equity
For the Year ended 2010 December 31

Exhibit 26: Statement of stockholders' equity

A corporation may reacquire its own capital stock as treasury stock to: (1) cancel and retire the stock; (2) reissue the stock later at a higher price; (3) reduce the shares outstanding and thereby increase earnings per share; or (4) issue the stock to employees. If the intent of reacquisition is cancellation and retirement, the treasury shares exist only until they are retired and canceled by a formal reduction of corporate capital.

For dividend or voting purposes, most state laws consider treasury stock as issued but not outstanding, since the shares are no longer in the possession of stockholders. Also, accountants do not consider treasury shares outstanding in calculating earnings per share. However, they generally consider treasury shares outstanding for purposes of determining legal capital, which includes outstanding shares plus treasury shares.

In states that consider treasury stock as part of legal capital, the cost of treasury stock may not exceed the retained earnings at the date the shares are reacquired. This regulation protects creditors by preventing the corporation in financial difficulty from using funds to purchase its own stock instead of paying its debts. Thus, if a corporation is subject to such a law (as is assumed in this text), the retained earnings available for dividends must exceed the cost of the treasury shares on hand.

When firms reacquire treasury stock, they record the stock at cost as a debit in a stockholders' equity account called Treasury Stock.  They credit reissuances to the Treasury Stock account at the cost of acquisition. Thus, the Treasury Stock account is debited at cost when shares are acquired and credited at cost when these shares are sold. Any excess of the reissue price over cost represents additional paid-in capital and is credited to Paid-In Capital – Common (Preferred) Treasury Stock Transactions.

To illustrate, assume that on 2010 February 18, the Hillside Corporation reacquired 100 shares of its outstanding common stock for USD 55 each. (The company's stockholders' equity consisted solely of common stock and retained earnings.) On 2010 April 18, the company reissued 30 shares for USD 58 each. The entries to record these events are:

When the reissue price of subsequent shares is less than the acquisition price, firms debit the difference between cost and reissue price to Paid-In Capital – Common Treasury Stock Transactions. This account, however, never develops a debit balance. By definition, no paid-in capital account can have a debit balance. If Hillside reissued an additional 20 shares at USD 52 per share on 2010 June 12, the entry would be:

At this point, the credit balance in the Paid-In Capital – Common Treasury Stock Transactions account would be USD 30. If the remaining 50 shares are reissued on 2010 July 16, for USD 53 per share, the entry would be:

Notice that Hillside has exhausted the Paid-In Capital –Common Treasury Stock Transactions account credit balance. If more than USD 30 is debited to that account, it would develop a debit balance. Thus, the remaining USD 70 of the excess of cost over reissue price is a special distribution to the stockholders involved and is debited to the Retained Earnings account.

Sometimes stockholders donate stock to a corporation. Since donated treasury shares have no cost to the corporation, accountants make only a memo entry when the shares are received. The only formal entry required is to debit Cash and credit the Paid-In Capital – Donations account when the stock is reissued. For example, if donated treasury stock is sold for USD 5,000, the entry would be:

When treasury stock is held on a balance sheet date, it customarily appears at cost, as a deduction from the sum of total paid-in capital and retained earnings, as follows:

Hypothetical Corporation
Partial balance sheet 2010 December 31

Exhibit 27: Stockholders' equity section of the balance sheet

An accounting perspective:

Business insight

General Mills is a leading producer of ready-to-eat cereals, desserts and baking mixes, snack products, and dinner and side dish mixes. Popular brand names include Hamburger Helper, Betty Crocker, and Yoplait. For 2001 and 2000, General Mills reported common stock in the treasury (treasury stock) of 123,100,000 and 122,900,000 shares, respectively. General Mills deducted the cost of these shares in the stockholders' equity section of the balance sheet.

To summarize much of what we have discussed in Chapters 12 and 13, we present the stockholders' equity section of the balance sheet in Exhibit 27. This partial balance sheet shows: (1) the amount of capital assigned to shares outstanding; (2) the capital contributed for outstanding shares in addition to that assigned to the shares; (3) other forms of paid-in capital; and (4) retained earnings, appropriated and unappropriated.

Anson Company Income Statement
For the Year Ended
2010 December 31

Exhibit 28: Income statement