Basics of accounting for treasury stock transactions

May 13, 2014

Corporations are capable of purchasing its own shares of stock on the open market, but these types of transactions are not accounted for like normal investments. In this article, we’ll go over basic accounting procedures to use when the company buys, sells, or retires treasury stock.

1. Conceptual theory

When a company buys and sells its own stock, you might think there is a possibility of income statement gains and losses when purchase and sale prices are different. Although gains and losses are realized, they are never recognized on the income statement because companies shouldn’t report current income or loss on transactions involving their own ownership shares. They can, however, be recognized as direct additions to and reductions from stockholder’s equity on the balance sheet.

There are two allowable methods of treasury stock accounting under U.S. GAAP. An overwhelming number of companies use the cost method, so we won’t discuss the par value method in this article.

2. Cost method of treasury stock accounting

When a company purchases its own stock, the entry is simply a debit to treasury stock - a contra equity account - and a credit to cash. No gain or loss is recorded in equity accounts regardless of the purchase price. Let’s assume that in 20X3, Friends Company buys 1,000 shares with a par value of $1 for $5 per share. The shares were originally issued for $2 per share. The following entry would be recorded for the purchase.

Account Names

Debits

Credits

Treasury stock

5,000

 

       Cash

 

5,000

Note that the par value of $1 does not have any impact on the purchase of stock by the company.

Changes in shareholder’s equity will be booked when the company later resells treasury stock. Let’s look at what happens when the company sells half the shares on January 1, 20X4, for $8 per share.

Account Names

Debits

Credit

Cash

4,000

 

       Treasury stock

 

2,500

       Additional paid-in capital – Treasury stock

 

1,500

Notice that the funds received over and above the purchase price are placed in a new additional paid-in capital account and not retained earnings. Let’s look at what happens if Friends sells the remaining shares at par value ($1) after a fire destroys half the company’s assets.

Account Names

Debits

Credits

Cash

500

 

Additional paid-in capital – Treasury stock

1,500

 

Retained earnings

500

 

       Treasury stock

 

2,500

Note here that the paid-in capital account is not sufficient to absorb the loss on the sale. When that happens, retained earnings should be debited (reduced) for the amount of the shortfall.

3. Retirement of treasury stock

When a corporation retires treasury stock, it should book a loss or gain to shareholder’s equity based on the purchase price and par value. Unlike the other transactions, the retirement entry will depend on the original issue price. In our previous example, if Friends Company immediately retired all 1,000 shares, it would make the following entry under the cost method.

Account Names

Debits

Credits

Common stock *

1,000

 

Additional paid-in capital – Common stock **

1,000

 

Additional paid-in capital or retained earnings

3,000

 

       Treasury stock

 

5,000

(*) Common stock amount is the $1 par value for 1,000 shares.

(**) Additional paid-in capital for common stock is the $2 original issue price minus $1 par value for 1,000 shares.

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