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Stockholders' Equity Explanation | AccountingCoach

source : accountingcoach.com

Stockholders’ Equity Explanation | AccountingCoach

A corporation may choose to reacquire some of its outstanding stock from its shareholders when it has a large amount of idle cash and, in the opinion of its directors, the market price of its stock is too low. If a corporation reacquires a significant amount of its own stock, the corporation’s earnings per share may increase because there are fewer shares outstanding.

If a corporation reacquires some of its stock and does not retire those shares, the shares are called treasury stock. Treasury stock reflects the difference between the number of shares issued and the number of shares outstanding. When a corporation holds treasury stock, a debit balance exists in the general ledger account Treasury Stock (a contra stockholders’ equity account). There are two methods of recording treasury stock: (1) the cost method, and (2) the par value method. (We will illustrate the cost method. The par value method is illustrated in intermediate accounting textbooks.)

Under the cost method, the cost of the shares acquired is debited to the account Treasury Stock. For example, if a corporation acquires 100 shares of its stock at each, the following entry is made:

Stockholders’ equity will be reported as follows:

If the corporation were to sell some of its treasury stock, the cash received is debited to Cash, the cost of the shares sold is credited to the stockholders’ equity account Treasury Stock, and the difference goes to another stockholders’ equity account. Note that the difference does not go to an income statement account, as there can be no income statement recognition of gains or losses on treasury stock transactions. (This, of course, is reasonable since the corporation operates with total “insider” information.)

If the corporation sells 30 of the 100 shares of its treasury stock for per share, the entry will be:

Recall that the corporation’s cost to purchase those shares at an earlier date was per share. The per share times 30 shares equals the 0 that was credited above to Treasury Stock. This leaves a debit balance in the account Treasury Stock of 1,400 (70 shares at each).

The difference of per share ( of proceeds minus the cost) times 30 shares was credited to another stockholders equity account, Paid-in Capital from Treasury Stock. Although the corporation is better off by per share, the corporation cannot report this “gain” on its income statement. Instead the 0 goes directly to stockholders’ equity in the paid-in capital section as shown below.

If the corporation sells any of its treasury stock for less than its cost, the cash received is debited to Cash, the cost of the shares sold is credited to Treasury Stock, and the difference (“loss”) is debited to Paid-in Capital from Treasury Stock (so long as the balance in that account will not become a debit balance). If the “loss” is larger than the credit balance, part of the “loss” is recorded in Paid-in Capital from Treasury Stock (up to the amount of the credit balance) and the remainder is debited to Retained Earnings. To illustrate this rule, let’s look at several transactions where treasury stock is sold for less than cost.

We will continue with our example from above. Recall that the cost of the corporation’s treasury stock is per share. The corporation now sells 25 shares of treasury stock for per share and receives cash of 0. As mentioned previously, the “loss” per share ( proceeds minus the cost) cannot appear on the income statement. Instead the “loss” goes directly to the account Paid-in Capital from Treasury Stock (if the account’s credit balance is greater than the “loss” amount). Since the 0 credit balance in Paid-in Capital from Treasury Stock is greater than the 0 debit, the entire 0 is debited to that account:

After making this entry, the stockholders’ equity section of the balance sheet appears as follows:

After the 25 shares of treasury stock are sold, the balance in Treasury Stock becomes a debit of 0 (45 shares at their cost of per share). The Paid-in Capital from Treasury Stock now shows a credit balance of 0.

Now let’s illustrate what happens when the next sale of treasury stock results in a “loss” and it exceeds the credit balance in Paid-in Capital from Treasury Stock. Let’s assume that the remaining 45 shares of treasury stock are sold by the corporation for per share and the proceeds total 0. Since the cost of those treasury shares was 0 (45 shares at a cost of each) there will be a “loss” of 0. This 0 is too large to be absorbed by the 0 credit balance in Paid-in Capital from Treasury Stock. As a result, the first 0 of the “loss” goes to Paid-in Capital from Treasury Stock and the remaining 0 (0 minus 0) is debited to Retained Earnings as shown in the following journal entry.

Again, no income statement account was involved with the sale of treasury stock, even though the shares were sold for less than their cost. The difference between the cost of the shares sold and their proceeds was debited to stockholders’ equity accounts. The debit was applied to Paid-in Capital from Treasury Stock for as much as that account’s credit balance. Any “loss” greater than the credit balance was debited to Retained Earnings. The stockholders’ equity section of the balance sheet now appears as follows.

Accumulated Other Comprehensive Income

Accumulated other comprehensive income refers to income not reported as net income on a corporation’s income statement. These items involve things such as foreign currency transactions, hedges, and pension liabilities.

Below is an example of the reporting of Accumulated Other Comprehensive Income of ,000. Notice that it is reported separately from retained earnings and separately from paid-in capital.

Treasury Stock on the Balance Sheet

Treasury Stock on the Balance Sheet – When analyzing a balance sheet, you're likely to run across an entry under the shareholders' equity section called treasury stock. The dollar amount of treasury stock recorded on the balance sheet refers to the cost of the shares a company has issued and subsequently reacquired, either through a share repurchase program or other means.Treasury stock is not an asset, it is a contra-equity account that is reported as a deduction in the stockholders' equity section of the balance sheet. In above example, treasury stock purchased by Eastern company should appear in the balance sheet as follows:Stockholders' equity will be reported as follows: If the corporation were to sell some of its treasury stock, the cash received is debited to Cash, the cost of the shares sold is credited to the stockholders' equity account Treasury Stock, and the difference goes to another stockholders' equity account.

Treasury stock – cost method – explanation, journal – To measure return on equity without the effect of treasury stock, add back the amount of treasury shares listed in the equity section of the balance sheet. For example, with the purchase of treasury stock, Sunny Sunglasses Shop's return on equity is 50.7%, and without treasury stock Sunny's return on equity is 46.8%.Treasury Stock is normally reported as:Multiple ChoiceAn expense account.An asset account.A liability account.A reduction of total stockholders' equity.Treasury Stock is normally reported as: A reduction of total stockholders' equity.

Treasury stock - cost method - explanation, journal

Treasury Stock and Accumulated Other Comprehensive Income – Where is treasury stock reported on the balance sheet? Under the cost method of recording treasury stock, the cost of treasury stock is reported at the end of the Stockholders' Equity section of the balance sheet. Treasury stock will be a deduction from the amounts in Stockholders' Equity.When a company buys back the shares or avail the option of treasury stock, the number of shares in the market is reduced. Therefore, treasury stock is also known as a contra equity account.Treasury Stock is normally reported as: A reduction of total stockholders' equity.

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