Treasury Stock is not a third kind of stock.
It is a company’s own common stock that it has reacquired.
There are a number of reasons why a company might repurchase its own common stock.
A few reasons are listed here on the slide
and include signaling the market that they think the stock is a good value;
or they might need shares of stock for employee compensation plans;
and potentially to try to prevent takeover bids from corporate raiders.
Treasury Stock is not an asset account.
It is a contra-equity account.
It has a normal debit balance and its companion account is usually Common Stock.
Because it has a debit balance, it reduces equity.
In order to see how treasury stock impacts equity,
Let’s look at this example from Mumford & Son’s.
You can see the company’s Paid-in Capital amounts as well as Retained Earnings.
Let's see how these change with the purchase and resale of treasury stock.
In this example, Mumford & Son’s purchases 10,000 shares of its common stock
for $10 per share.
So we would debit Treasury Stock and credit Cash for $100,000.
Treasury Stock is always accounted for at its cost,
so the cost of these shares is now $10 per share.
The Stockholders’ Equity section, after the purchase, looks like this.
Notice Treasury Stock is listed after Retained Earnings and is a reduction in equity.
When Mumford & Son’s reissues its stock back to the market,
there are three possible outcomes: it can sell at cost, above cost, or below cost.
Let’s look at an example of each.
In this example, Mumford & Son’s reissues 2,000 shares of its treasury stock
at $10 per share-its cost.
So we would debit Cash and credit Treasury Stock for $20,000.
The Stockholders’ Equity section after the reissuance looks like this.
Notice that Treasury Stock is now $20,000 less,
and equity has increased by $20,000 because of it.
In this example, Mumford & Son’s
reissues 4,000 shares of its treasury stock at $12 per share,
which is above cost.
So we would debit Cash for 48,000
and credit Treasury Stock for $40,000, its cost.
We also credit Paid-In Capital for Treasury Stock for $8,000.
This is the amount we reissued the stock for above its cost.
The Stockholders’ Equity section after the reissuance looks like this.
Notice that Paid-in Capital for Treasury Stock is listed in the Paid-In Capital section
and Treasury Stock has been reduced by another $40,000,
and equity has increased by $48,000.
Finally, Treasury Stock can be reissued below cost if a company needs cash
or thinks the stock price will drop even further.
In this extreme example, Mumford & Son’s reissues 4,000 shares of its treasury stock
for $5 per share, which is $5 below its cost.
So I want to show you the journal entry is stages.
We would debit Cash for $20,000 and credit Treasury Stock for $40,000, its cost.
This leaves us missing $20,000 of debits.
When this happens, the first account we reduce is Paid-In Capital for Treasury Stock.
However, we can only debit this account for its available balance, which in this case is $8,000.
When there isn’t enough balance available in the Paid-In Capital for Treasury Stock account,
the remaining amount needs to come from Retained Earnings.
So Retained Earnings needs to be debited $12,000 to make the journal entry balance.
The Stockholders’ Equity section after all of these transactions is shown here.
Treasury Stock is gone because all the stock was reissued.
Paid-In Capital for Treasury Stock is gone,
because we used that available balance when we sold stock below cost.
Finally, Retained Earnings has decreased by $12,000
to cover the amount needed when the stock was sold below cost.