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 (EPS).

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’ equity.

The two methods of accounting treasury stock are cost method and the par value method. In the cost 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.

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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 company.
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 earnings, is $1, 20,000. This repurchase of the stocks leads to a contra account. 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 sheet 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 issued 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 Shares 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 liquidation.

Reasons for Share Buy Back

There are numerous reasons behind the buyback of issued shares 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 interest – 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 equity in terms of return using that fund. The company is not making any economic profit. 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 ratios – 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) ratios. These ratios give a clear understanding of the positive company market performance.