When a company decides to buy back its shares and does not retire or cancel them, the purchased shares are recorded on the company's books as treasury stock. The two treasury stock accounting methods are the cost method, which is the most commonly used method, and the par value method. A company's profit/loss calculation is unaffected by treasury stock transactions, which involve balance sheet accounts only.
Under the cost method of accounting, share repurchases are recorded in the treasury stock account in the shareholders' equity section of the balance sheet. For example, if a company buys back 1 million of its publicly traded shares at a cost of $5 each, the accounting entries are to debit or increase the treasury stock account and credit or decrease cash by $5 million ($5 x 1 million) each. Treasury stock is a contra account that reduces the value of shareholders' equity. According to Harold Averkamp of AccountingCoach, treasury stock reflects the difference between the values of a publicly traded company's issued and outstanding shares.
Treasury Stock Reissue
The AccountingTools website reports that the underlying assumption of the cost method is that the repurchased shares will be resold. The selling price may be lower or higher than the purchase price. If the selling price is higher, the surplus is added to the paid-in capital account. Continuing with the example, if the company sells the treasury shares for $6, the accounting entries are to debit or increase cash by $6 million ($6 x 1 million), credit or decrease treasury stock by $5 million and credit or increase the paid-in capital account by $1 million ($6 million - $5 million). If the selling price is lower, the deficit is deducted from the paid-in capital account.
Par Value Method
The par value method is used when the repurchased shares are retired permanently. The par value and issuing price of the shares are used to record the transactions. For example, if a company buys back and retires 100,000 shares, which have a par value of $0.50 per share and were issued for $4.50 per share, for $6 per share, then the accounting entries are to debit treasury stock by $50,000 (100,000 x $0.50), debit paid-in capital by $400,000 [100,000 x ($4.50 - $0.50) = 100,000 x $4 = $400,000], debit retained earnings by $150,000 [100,000 x ($6 - $4.50) = 100,000 x $1.50 = $150,000] and credit cash by $600,000 ($6 x 100,000).
Treasury stock and common stock are separately accounted for in the shareholders' equity section of a company's balance sheet. When a company sells shares that were not part of any repurchase, it increases the common stock account for the par value of the shares, increases the paid-in capital account for the difference between the market value and the par value of the shares and increases the cash account for the cash proceeds received.