Friday, February 8, 2013

Purchasing Treasury Stock: How to Visual Explanation

Purchasing Treasury Stock

Purchasing treasury stock reduces the corporation’s assets and equity by equal amounts. (We describe the cost method of accounting for treasury stock, which is the most widely used method. The par value method is another method explained in advanced courses.) To illustrate, Exhibit 13.13 shows Cyber Corporation’s account balances before any treasury stock purchase (Cyber has no liabilities).

EXHIBIT 13.13Account Balances before Purchasing Treasury Stock

Cyber then purchases 1,000 of its own shares for $11,500 on May 1, which is recorded as follows.



 
This entry reduces equity through the debit to the Treasury Stock account, which is a contra equity account. Exhibit 13.14 shows account balances after this transaction.

EXHIBIT 13.14Account Balances after Purchasing Treasury Stock

The treasury stock purchase reduces Cyber’s cash, total assets, and total equity by $11,500 but does not reduce the balance of either the Common Stock or the Retained Earnings account. The equity reduction is reported by deducting the cost of treasury stock in the equity section. Also, two disclosures are evident. First, the stock description reveals that 1,000 issued shares are in treasury, leaving only 9,000 shares still outstanding. Second, the description for retained earnings reveals that it is partly restricted.

Point: The Treasury Stock account is not an asset. Treasury stock does not carry voting or dividend rights.

Point: A treasury stock purchase is also called a stock buyback.

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