Treasury Stock

A corporation may choose to reacquire some of its outstanding stock from its shareholders when it
has a large amount of idle cash and, in the opinion of its directors, the market price of its stock is too
low. If a corporation reacquires a significant amount of its own stock, the corporation's earnings
per share may increase because there are fewer shares outstanding.
If a corporation reacquires some of its stock and does not retire those shares, the shares are called
treasury stock. Treasury stock reflects the difference between the number of shares issued and the
number of sharesoutstanding. When a corporation holds treasury stock, a debit balance exists in
the general ledger account Treasury Stock (a contra stockholders' equity account). There are two
methods of recording treasury stock: (1) the cost method, and (2) the par value method. (We will
illustrate the cost method. The par value method is illustrated in intermediate accounting textbooks.)
Under the cost method, the cost of the shares acquired is debited to the account Treasury Stock. For
example, if a corporation acquires 100 shares of its stock at $20 each, the following entry is made:

Stockholders' equity will be reported as follows:

If the corporation were to sell some of its treasury stock, the cash received is debited to Cash,
the cost of the shares sold is credited to the stockholders' equity account Treasury Stock, and the
difference goes to another stockholders' equity account. Note that the difference does not go to an
income statement account, as there can be no income statement recognition of
gains or losses on treasury stock transactions. (This, of course, is reasonable since the
corporation operates with total "insider" information.)
If the corporation sells 30 of the 100 shares of its treasury stock for $29 per share, the entry will be:

Recall that the corporation's cost to purchase those shares at an earlier date was $20 per share. The
$20 per share times 30 shares equals the $600 that was credited above to Treasury Stock. This
leaves a debit balance in the account Treasury Stock of $1,400 (70 shares at $20 each).
The difference of $9 per share ($29 of proceeds minus the $20 cost) times 30 shares was credited to
another stockholders equity account, Paid-in Capital from Treasury Stock. Although the corporation is
better off by $9 per share, the corporation cannot report this "gain" on its income statement. Instead
the $270 goes directly to stockholders' equity in the paid-in capital section as shown below.

If the corporation sells any of its treasury stock for less than its cost, the cash received is debited to
Cash, the cost of the shares sold is credited to Treasury Stock, and the difference ("loss") is debited
to Paid-in Capital from Treasury Stock (so long as the balance in that account will not become a debit
balance). If the "loss" is larger than the credit balance, part of the "loss" is recorded in Paid-in Capital
from Treasury Stock (up to the amount of the credit balance) and the remainder is debited to
Retained Earnings. To illustrate this rule, let's look at several transactions where treasury stock is
sold for less than cost.
We will continue with our example from above. Recall that the cost of the corporation's treasury stock
is $20 per share. The corporation now sells 25 shares of treasury stock for $16 per share and
receives cash of $400. As mentioned previously, the $4 "loss" per share ($16 proceeds minus the
$20 cost) cannot appear on the income statement. Instead the "loss" goes directly to the account
Paid-in Capital from Treasury Stock (if the account's credit balance is greater than the "loss"
amount). Since the $270 credit balance in Paid-in Capital from Treasury Stock is greater than the
$100 debit, the entire $100 is debited to that account:

After making this entry, the stockholders' equity section of the balance sheet appears as follows:

After the 25 shares of treasury stock are sold, the balance in Treasury Stock becomes a debit of
$900 (45 shares at their cost of $20 per share). The Paid-in Capital from Treasury Stock now shows
a credit balance of $170.
Now let's illustrate what happens when the next sale of treasury stock results in a "loss" and it
exceeds the credit balance in Paid-in Capital from Treasury Stock. Let's assume that the remaining
45 shares of treasury stock are sold by the corporation for $12 per share and the proceeds total
$540. Since the cost of those treasury shares was $900 (45 shares at a cost of $20 each) there will
be a "loss" of $360. This $360 is too large to be absorbed by the $170 credit balance in Paid-in
Capital from Treasury Stock. As a result, the first $170 of the "loss" goes to Paid-in Capital from
Treasury Stock and the remaining $190 ($360 minus $170) is debited to Retained Earnings as shown
in the following journal entry.

Again, no income statement account was involved with the sale of treasury stock, even though the
shares were sold for less than their cost. The difference between the cost of the shares sold and their
proceeds was debited to stockholders' equity accounts. The debit was applied to Paid-in Capital from
Treasury Stock for as much as that account's credit balance. Any "loss" greater than the credit

balance was debited to Retained Earnings. The stockholders' equity section of the balance sheet
now appears as follows.