Principles of Financial Accounting: Stockholders' Equity - Treasury Stock, Cost Method Purchase Reissuance Retirement

What It Is

Treasury stock, also known as reacquired stock, is a type of stock that a company repurchases from its shareholders. This can be done for various reasons, such as to reduce the number of outstanding shares, to buy back shares at a lower price than the original issue price, or to prevent a hostile takeover. If a company buys $10,000 of treasury stock, it will be recorded as a reduction in shareholders' equity.

Key Concepts & Formulas

• Cost Method: The cost method is used to record treasury stock purchases. It involves debiting Treasury Stock (a contra-equity account) and crediting Cash. Cost Method Formula: Treasury Stock = Cost of Treasury Stock
• Treasury Stock Account: Treasury Stock is a contra-equity account that represents the cost of treasury stock purchased. Treasury Stock Formula: Treasury Stock = Cost of Treasury Stock
• Cost of Treasury Stock: The cost of treasury stock is the amount paid to purchase the shares. Cost of Treasury Stock Formula: Cost of Treasury Stock = Purchase Price x Number of Shares
• Reissuance of Treasury Stock: When treasury stock is reissued, the company debits Cash and credits Treasury Stock. Reissuance Formula: Cash = Cost of Treasury Stock + Gain/Loss on Reissuance
• Retirement of Treasury Stock: When treasury stock is retired, the company debits Treasury Stock and credits Retained Earnings. Retirement Formula: Retained Earnings = Cost of Treasury Stock
• Treasury Stock Ratio: The treasury stock ratio is calculated by dividing the cost of treasury stock by the total shareholders' equity. Treasury Stock Ratio Formula: Treasury Stock Ratio = (Cost of Treasury Stock ÷ Total Shareholders' Equity) x 100

Journal Entry Examples

1. Purchase of Treasury Stock: Dr. Treasury Stock $5,000 Cr. Cash $5,000

Explanation: The company purchases treasury stock for $5,000, so it debits Treasury Stock and credits Cash.

1. Reissuance of Treasury Stock: Dr. Cash $6,000 Cr. Treasury Stock $5,000 Cr. Gain on Reissuance $1,000

Explanation: The company reissues treasury stock for $6,000, so it debits Cash and credits Treasury Stock and Gain on Reissuance.

1. Retirement of Treasury Stock: Dr. Treasury Stock $5,000 Cr. Retained Earnings $5,000

Explanation: The company retires treasury stock, so it debits Treasury Stock and credits Retained Earnings.

Common Mistakes

1. Mistake: Confusing debits and credits for treasury stock purchases. Correction: Remember that treasury stock is a contra-equity account, so it is debited when purchased and credited when reissued or retired.

2. Mistake: Not considering the cost of treasury stock when calculating the treasury stock ratio. Correction: Make sure to include the cost of treasury stock in the numerator of the treasury stock ratio formula.

3. Mistake: Not distinguishing between treasury stock and retained earnings. Correction: Remember that treasury stock is a contra-equity account, while retained earnings is a regular equity account.

Exam Tips

1. Tip: When dealing with treasury stock, remember that it is a contra-equity account, so it will have a normal balance opposite of equity accounts.
2. Tip: Be careful when calculating the treasury stock ratio, as it requires the cost of treasury stock and total shareholders' equity.
3. Tip: When reissuing treasury stock, make sure to calculate the gain or loss on reissuance and record it in the journal entry.

Quick Practice

1. What is the journal entry for purchasing treasury stock for $10,000? Answer: Debit Treasury Stock $10,000 and credit Cash $10,000. Explanation: The company purchases treasury stock, so it debits Treasury Stock and credits Cash.

2. What is the adjusting entry for reissuing treasury stock for $12,000? Answer: Debit Cash $12,000 and credit Treasury Stock $10,000 and Gain on Reissuance $2,000. Explanation: The company reissues treasury stock, so it debits Cash and credits Treasury Stock and Gain on Reissuance.

3. What is the journal entry for retiring treasury stock for $8,000? Answer: Debit Treasury Stock $8,000 and credit Retained Earnings $8,000. Explanation: The company retires treasury stock, so it debits Treasury Stock and credits Retained Earnings.

Last-Minute Cram Sheet

1. Treasury stock is a contra-equity account that represents the cost of treasury stock purchased.
2. The cost method is used to record treasury stock purchases.
3. Treasury stock is debited when purchased and credited when reissued or retired.
4. The treasury stock ratio is calculated by dividing the cost of treasury stock by the total shareholders' equity.
5. Dividends are NOT an expense – they go directly to retained earnings.
6. Treasury stock is a contra-equity account, so it will have a normal balance opposite of equity accounts.
7. The cost of treasury stock is the amount paid to purchase the shares.
8. The gain or loss on reissuance is calculated by subtracting the cost of treasury stock from the reissuance price.
9. Treasury stock is NOT an asset – it is a contra-equity account.
10. The treasury stock ratio is an important metric for analyzing a company's financial health.