What is Treasury Stock?
Treasury Stocks are the set of shares which the issuing company has bought back from the existing shareholders of the company but not retired and thus they are not considered while calculating the earning per share or the dividends of the company.
These are the shares reacquired by the issuing company, from the shareholders, but not yet retired by the company. They reduce shareholder equity. Treasury Shares do not represent an investment in the firm. Also, it does not receive a dividend and has no voting rights. These treasury shares are not taken into account while calculating dividends or earnings per share (EPSEPSEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is.).
Treasury Stock in the Balance Sheet
The company reports treasury Shares at the end of the line items within the equity section. When the company repurchases the stock, it records the expenditure due to repurchase in a contra-equity account. Thus the direct effect of writing a treasury stock transaction is a reduction in the total amount of equity recorded in the balance sheet. It lists in the balance sheet as a negative number under shareholders’ equityNegative Number Under Shareholders' EquityNegative shareholders equity refers to the negative balance of the shareholder's equity, which arises when the company's total liabilities are more than the value of its total assets. The reasons for such negative balance include accumulated losses, large dividend payments, and large borrowing for covering accrued losses..
The two methods of accounting treasury stock are cost method and the par value method. In the cost methodCost MethodThe cost method is a method of accounting for investments in which the investment remains at its original cost on the balance sheet. Many financial instruments, such as investments and inventory/fixed assets, are accounted for using this method., the paid-in capital account is reduced in the balance sheet when treasury shares are purchased. Under the par value method during repurchase, the books will record it as the retirement of shares. Thereby, common stock debits, and treasury stock credits. But in both methods, the transactions can’t increase the amount of retained earnings.
The example below from Colgate shows how treasury shares impact the shareholder’s equity of a company.
We see that Shareholder’ equity reduces by Treasury shares and is a negative number. Colgate follows the cost method and had $19.135 billion worth of Treasury Shares as of December 31, 2016.
Treasury Stock Examples
- Let us assume that Company ABC decides to reacquire some of its shares since these are currently undervalued in the open market. When Company ABC buys these shares back, then they become Treasury Stock. It must keep in mind that if Company ABC decides to resell these, then the profit or losses are not recognized in the income statement of the companyIncome Statement Of The CompanyThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements..
- Suppose Company ABC has excess cash and sees that its stock in the market is trading below its intrinsic value. So it decides to buy back 1,000 shares of its stock at $60 for a total value of $60,000. The total sum of the company’s equity accounts, including common stock and retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company., is $1, 20,000. This repurchase of the stocks leads to a contra accountContra AccountContra Account is an opposite entry passed to offset its related original account balances in the ledger. It helps a business retrieve the actual capital amount & amount of decrease in the value, hence representing the account’s net balances. . Following which the $60,000 repurchase is deducted from $1,20,000 equity account balance, leaving a difference of $60,000. Similarly, the cash account on the asset side of the balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company. decreases by $60,000.
Treasury Shares Example – Colgate
source: Colgate SEC Filings
We note from above that Colgate has been buying back shares each year.
- In 2014, Colgate bought back 23,131,081 shares. Due to share s issued for stock options and shares issuedShares IssuedShares Issued refers to the number of shares distributed by a company to its shareholders, who range from the general public and insiders to institutional investors. They are recorded as owner's equity on the Company's balance sheet. for restricted stock units, the balance treasury stocks at the end of 2014 was 558,994,215 shares.
- Likewise, in 2015, Colgate bought back 22,802,784 shares, and in 2016, Colgate bought back 19,271,304 treasury shares.
Difference Between Treasury stocks and Outstanding shares
|Treasury Stocks||Outstanding Shares|
|Treasury Shares have no voting rights||Outstanding SharesOutstanding SharesOutstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet. Has voting rights|
|These do not receive any dividends||All shareholders of the other outstanding shares receive a dividend|
|The company don’t include Treasury Shares in the calculation of outstanding shares||Included in the calculation of outstanding shares|
|Treasury Shares cannot exercise privileged rights as shareholders||Can exercise privileged rights as shareholders|
|Every country’s governing body regulates the number of such stocks a company can hold.||No such restriction applies to other outstanding shares.|
|Treasury Shares do not receive assets on company liquidation.||A shareholder of the other outstanding shares receives assets on company liquidationCompany LiquidationLiquidation is the process of winding up a business or a segment of the business by selling off its assets. The amount realized by this is used to pay off the creditors and all other liabilities of the business in a specific order..|
Reasons for Share Buy Back
There are numerous reasons behind the buyback of issued sharesBuyback Of Issued SharesShare buyback refers to the repurchase of the company’s own outstanding shares from the open market using the accumulated funds of the company to decrease the outstanding shares in the company’s balance sheet. This is done either to increase the value of the existing shares or to prevent various shareholders from controlling the company. from the open market as well as the investors. Some of the reasons are listed below:
- Reselling Purpose – They are often kept aside as reserved stock to raise finances or for future investments. A company may utilize the treasury stock to acquire a competing company.
- For controlling interestControlling InterestA controlling interest is the shareholder's power to speak in the corporate actions or decisions derived from possessing a considerable chunk of the company's voting stock. However, such a stakeholder may or may not hold a significant portion of the company's common stocks. – Due to buying back of stock, the number of outstanding shares in the open market is reduced, which leads to an increment in the value of remaining shareholders’ interest in the company. With the help of repurchasing sudden takeovers in case of failed acquisitions can be avoided by the company management.
- Undervaluation – In some cases, when the market is performing poorly, the company’s stock may be underpriced in the open market. Buying back the stock usually gives a positive push to the share price, and the remaining shareholders eventually benefit.
- Retiring of Shares – If the treasury shares are labeled as retired, then they cannot be sold and are removed from the market circulation. It leads to a permanent reduction, thus forcing the remaining shares in the open market to serve as a larger percentage of the shareholders’ ownership.
- Reducing the cost of capital – Shareholders lend capital to a company for its operations and expansion when a company is unable to generate more than the cost of equityCost Of EquityCost of equity is the percentage of returns payable by the company to its equity shareholders on their holdings. It is a parameter for the investors to decide whether an investment is rewarding or not; else, they may shift to other opportunities with higher returns. in terms of return using that fund. The company is not making any economic profitEconomic ProfitEconomic profit refers to the income acquired after deducting the opportunity and explicit costs from the business revenue (i.e., total income minus overall expenses). It is an internal analysis metric used by the organizations along with the accounting profits.. In that case, it is preferable to return some portion of the shareholder’s fund and reduce the percentage of shareholding. It will help in reducing the cost of capital for the company and increase its value.
- Improvement of financial ratiosFinancial RatiosFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on. – If the company has a positive reason for reacquiring stocks, then as an aftermath, the financial ration will improve. It, in turn, leads to an increase in return on assets (ROA) and return on equity (ROE) ratiosReturn On Equity (ROE) RatiosReturn on Equity (ROE) represents financial performance of a company. It is calculated as the net income divided by the shareholders equity. ROE signifies the efficiency in which the company is using assets to make profit.. These ratios give a clear understanding of the positive company market performance.
Treasury Stock Video
This article has been a guide to what is Treasury Stock. Here we discuss treasury stocks in the balance sheet, and it’s accounting along with practical examples. We also discuss differences between treasury shares and outstanding shares and the reasons why a company goes for buybacks. You can learn more about Corporate Finance here –