Treasury stock are shares that have been issued, but which the firm has repurchased from investors. Thus, treasury shares are no longer outstanding (but are still issued). Treasury shares can be resold to investors (and be outstanding again), or they can be cancelled (in that case they are no longer issued).
Economically, treasury stock is an asset. Also, a firm can make money with trading in their own stock. In order to mitigate the incentive for management to increase profits with trading in their own shares, accounting regulation requires that the asset treasury shares be deducted from equity, and that gains and losses on trading in treasury shares are not included in net income, but instead are booked straight into equity. This is an exception to the rule that all revenues and expenses are recorded on temporary T-accounts.
Gains are added to a T-account called ‘additional paid in capital, treasury shares’. Losses are subtracted from previous gains. To the extent that cumulative losses exceed cumulative gains, losses are subtracted from retained earnings.
Treasury Stock Example
The firm buys 1,000 of its own shares for 50 each. The firm had not previously purchased treasury shares.
The journal entry:
The firm sells 400 treasury shares for 52 each:
|Additional paid-in capital, treasury shares||800|
The firm sells the remaining 600 treasury shares for 47 each:
|Additional paid in capital, treasury shares||800|
On the sale of the 600 shares a loss is made of 1,800 (=600 x (50-47)). Previous cumulative gains (and losses) on ‘additional paid in capital, share premium’ amount to 800, which is reduced to zero and the remaining loss of 1,000 is subtracted from retained earnings.
Treasury Stock Explained
– treasury shares are shares that the company has repurchased, but not cancelled; these
– treasury shares are issued, but not outstanding
– treasury shares is deducted from equity
– gains/losses on treasury shares are not included in net income, but added/subtracted from equity
– gains are added to ‘additional paid-in capital, share premium’; losses are subtracted from this T-account (if it has a positive balance), or otherwise subtracted from retained earnings