Treasury stock refers to the shares of a corporation that have been issued and subsequently reacquired by the issuing company. These shares can be either common or preferred stock. Unlike outstanding shares, treasury stock does not confer voting rights and does not pay dividends, as it is no longer considered part of the company’s outstanding shares.
Key Uses and Purposes of Treasury Stock
Stock Bonus Plan
One of the primary uses of treasury stock is to facilitate stock bonus plans for management and employees. By reacquiring shares, a company can manage its stock compensation programs without issuing new shares, thus limiting dilution of existing shares.
Corporate Acquisitions
Treasury stock can be utilized to acquire another company. By using shares from its treasury, a company can finance acquisitions without impacting its current shareholder base or needing additional cash resources.
Accounting for Treasury Stock
Purchase and Reissuance
When a company purchases its own shares, the cost of these shares is recorded as a contra equity account known as treasury stock on the balance sheet, which reduces the total equity. Treasury stock is usually recorded at the cost of purchase rather than at par value.
Example:
If a company reacquires 1,000 shares at $20 per share, the journal entry would be:
Later, if the company reissues these shares, the accounting treatment depends on whether the shares are sold at, above, or below their reacquisition cost.
Special Considerations
Non-Participation in Dividends
Since treasury shares are not outstanding shares, they do not receive dividends. This impacts the accounting and financial analysis of dividend yields and dividend distribution models.
Impact on Earnings Per Share (EPS)
Treasury stock reduces the number of shares outstanding, potentially increasing EPS. This can be a strategy for improving perceived profitability, as EPS is a critical metric for investors.
Regulatory and Governance Implications
There are regulatory requirements surrounding stock repurchases, such as limits on the percentage of shares that can be repurchased. Corporate governance policies may additionally restrict how and when company stock can be reacquired.
Historical Context
Evolution of Stock Repurchase Practices
Historically, stock repurchases were seen less frequently prior to the 1980s due to strict regulatory environments and differing market practices. Over the past few decades, regulatory changes, such as the SEC’s Rule 10b-18, have facilitated a more liberal framework under which companies can repurchase shares.
Related Terms
- Outstanding Shares: Shares currently held by all shareholders, including share blocks held by institutional investors and restricted shares owned by company officers and insiders.
- Contra Equity Account: An account that reduces the total equity on the balance sheet, typically used in the context of treasury stock.
- Stock Repurchase: The act of a company buying back its own shares from the marketplace, reducing the number of outstanding shares.
FAQs
What happens to the voting rights of treasury stock?
How does treasury stock affect financial statements?
Can treasury stock be reissued?
References
- SEC Rule 10b-18, “Purchases of Certain Equity Securities by the Issuer and Others.”
- Accounting Standards Codification (ASC) 505, “Equity.”
Summary
Treasury stock represents shares that are issued and subsequently repurchased by the company. It serves crucial roles in employee compensation plans and strategic acquisitions, and has significant accounting treatments and regulatory implications. By managing treasury stock effectively, companies can influence various financial metrics and optimize their capital structure.
