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 shares that has been 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
Treasury Shares are usually reported at the end of the line items within the equity section. When the company repurchases the stock, the expenditure due to repurchase is recorded 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 is listed on 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 is debited and treasury stock is credited. 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’s equity is reduced 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 takes a decision to reacquire some of its shares since the shares of Company ABC 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 stock, then the profit or losses on the accounting treasury stock transaction 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 thus leaving a difference of $60,000. In a similar manner, the cash account on the asset side of the balance sheet is decreased 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 |
| Treasury Shares do not receive any dividends | All shareholders of the other outstanding shares receive dividend |
| Treasury Shares are not included 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 |
| The number of such stocks a company can hold is regulated by every country’s governing body. | No such restriction is applicable for 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 repurchase 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 in a poor manner, 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 are eventually benefitted.
- Retiring of Shares – If the treasury shares are labeled as retired then they cannot be sold and are removed from the market circulation. This 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 not able 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. This 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 financial ration will improve. This, 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.
Treasury Stock Video
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This has been a guide to what is Treasury Stock. Here we discuss treasury stocks in the balance sheet, 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 –
