58 CHATGPT Flashcards
WHAT IS TREASURY STOCK?
Treasury stock (or treasury shares) refers to shares that were once a part of the outstanding shares of a company but were subsequently reacquired by the company itself. These shares are essentially the company’s own shares that it has bought back from shareholders. Once these shares are repurchased, they can either be held by the company, retired (cancelled), or reissued in the future. While held by the company, treasury shares do not confer voting rights, do not pay dividends, and are not included in the calculation of earnings per share or other per-share metrics.
Companies might decide to buy back shares for several reasons:
To increase the value of remaining shares by reducing the supply in the market, potentially making each share more valuable.
To have shares available for employee compensation plans, mergers, or acquisitions.
To show confidence in the company’s future prospects, signaling to investors that the management believes the stock is undervalued.
To prevent or reduce the risk of a takeover by reducing the number of shares available for potential acquirers.
The accounting treatment of treasury stock can vary by country, but generally, it is recorded as a contra account to equity, meaning it reduces the total equity of the company in its balance sheet.
WHAT IS THE COST METHOD TO ACCOUNT FOR TREASURY STOCK?
The cost method of accounting for treasury stock is a common approach companies use to account for their own repurchased shares, also known as treasury shares. Under this method, the cost of the purchased treasury stock is recorded as a deduction from the total shareholders’ equity. Here’s how it works:
Purchase of Treasury Stock: When a company buys back its own shares, the purchase price of these shares is recorded in a treasury stock account. This account is a contra equity account, meaning it has a debit balance and is subtracted from the total shareholders’ equity. The entry to record the purchase of treasury stock would be a debit to the treasury stock account and a credit to cash (or cash equivalents), reflecting the outflow of cash to repurchase the shares.
Resale of Treasury Stock: If the company later decides to sell these shares, the method of recording depends on the sale price compared to the purchase cost.
If the shares are sold for more than their cost, the company credits the treasury stock account for the original cost of the shares and records the excess (the gain) in a paid-in capital account related to treasury stock (not as revenue in the income statement).
If the shares are sold for less than their cost, the company credits the treasury stock account for the original cost and debits the difference (the loss) from paid-in capital related to treasury stock to the extent available, with any remainder charged against retained earnings.
Retirement of Treasury Stock: If a company decides to retire treasury shares, it removes the shares from the accounts. The treasury stock account is debited for the cost of the shares, and the corresponding share capital (common or preferred stock) account is reduced by the par value of the shares. Any difference between the cost of treasury stock and the par value of the retired shares is adjusted against additional paid-in capital and, if necessary, retained earnings.
The cost method simplifies the accounting process for treasury stock transactions by focusing on the cost paid to acquire and the proceeds received from selling these shares, without affecting the income statement directly through gains or losses on buyback or resale transactions.
WHAT IS PAR VALUE OF STOCK?
Par value of stock refers to the nominal or face value assigned to a share of stock by the company’s charter when the stock is issued. It is a legal capital per share that is printed on the face of the stock certificate. Par value is often set at a very low amount, such as $0.01 or $1.00, and does not necessarily reflect the market value of the stock. The concept of par value has become somewhat outdated and is used more for legal and accounting purposes rather than representing the actual value of a share.
Here’s how par value functions in different contexts:
Common Stock: For common stock, the par value is a nominal amount that companies use to establish the minimum legal capital that must be retained in the business. When shares are issued at more than their par value, the excess amount over par value is recorded as “additional paid-in capital” (or “share premium”) in the shareholders’ equity section of the balance sheet.
Preferred Stock: The par value of preferred stock has more significance because it is often used to calculate dividend payments. Preferred dividends are typically set as a percentage of the par value.
Bond Par Value: While slightly different from stock, the concept of par value is also used for bonds, representing the face value or principal amount that will be repaid to bondholders at maturity. Bond interest payments are often expressed as a percentage of par value.
Accounting Implications: In accounting, the par value of issued shares is recorded in the common or preferred stock account within the equity section of the balance sheet. Any amount received over the par value is recorded separately in an additional paid-in capital account.
Despite its presence in financial statements, the par value of a stock has little relation to its market value, which is determined by the supply and demand dynamics in the stock market. Many companies choose a low par value to minimize the legal liability of shareholders or even issue no-par value stock, where shares are issued without a stated par value.
WHAT IS THE PAR VALUE METHOD TO ACCOUNT FOR TREASURY STOCK?
The par value method of accounting for treasury stock is one of the ways companies can account for the repurchase of their own shares. Unlike the cost method, which focuses on the actual cost paid to repurchase the shares, the par value method involves specific accounting treatments related to the stock’s par value. However, it’s important to note that the cost method is far more commonly used in practice. The description here is more of a theoretical overview since the par value method is not widely adopted for treasury stock transactions under current accounting standards.
In the par value method:
Purchase of Treasury Stock: When treasury stock is purchased, the transaction affects the accounts for common stock (or preferred stock, as the case may be) at their par value rather than at the purchase price. The difference between the purchase price and the par value of the shares is recorded in the additional paid-in capital (APIC) related to treasury stock, if the shares were originally issued above par value.
Recording Treasury Stock: Upon repurchase, the company debits the treasury stock account for the par value of the shares repurchased and debits additional paid-in capital (APIC) for any amount above par value, with the remaining amount (if the purchase price exceeds both the par value and the APIC available) debited to retained earnings.
Resale of Treasury Stock: When the treasury stock is resold, the company credits the treasury stock account for the par value of the shares and credits the additional paid-in capital related to treasury stock for the difference between the selling price and the par value, if sold above par. If sold below par, the company would adjust the additional paid-in capital and retained earnings accounts as necessary based on the selling price.
Impact on Financial Statements: The par value method directly impacts the equity section of the balance sheet through adjustments in the common stock (or preferred stock), additional paid-in capital, and possibly retained earnings accounts, reflecting the repurchase and resale of treasury shares at their par value and associated amounts.
It’s crucial to remember that the par value method is more of a conceptual approach to understanding how treasury stock transactions could be accounted for based on the par value of repurchased shares. In practice, the cost method is predominantly used, which records treasury stock transactions at the actual cost of repurchase and resale, without the direct adjustments to the common or preferred stock accounts at par value.
what are stock dividends?
Stock dividends are dividends paid out to shareholders of a company in the form of additional shares of stock, rather than cash payments. When a company issues stock dividends, it distributes a certain percentage of its profits or retained earnings to existing shareholders by giving them more shares of the company’s stock.
Stock dividends are usually expressed as a percentage, such as “10% stock dividend,” which means that for every 10 shares owned, the shareholder receives an additional share. However, the overall value of the investment remains the same because although the number of shares increases, the price per share decreases proportionally.
Stock dividends are often used by companies to reward shareholders without affecting the company’s cash reserves. They also provide shareholders with an opportunity to increase their ownership stake in the company without needing to invest additional capital. Additionally, stock dividends can sometimes be seen as a sign of financial health and stability in a company, as they demonstrate the company’s ability to generate profits and reinvest them in the business.
can you give examples of the cost method and par method of accounting for treasury stock?
Certainly! Treasury stock is stock that a company has repurchased from shareholders and now holds in its own treasury. There are two main methods of accounting for treasury stock: the cost method and the par value method.
Cost Method:
Under the cost method, treasury stock is recorded on the balance sheet at the price paid to repurchase the shares.
When treasury stock is repurchased, it is recorded by debiting the treasury stock account and crediting cash for the amount paid.
Any subsequent sale of treasury stock is recorded as a debit to cash and a credit to treasury stock for the amount received.
The difference between the sale price and the repurchase price is recorded as either a gain or loss on the income statement.
Example:
Let’s say a company repurchases 1,000 shares of its own stock for $20 per share. The entry to record the repurchase would be:
Debit Treasury Stock $20,000
Credit Cash $20,000
If the company later sells 500 of these shares for $25 per share, the entry to record the sale would be:
Debit Cash $12,500
Credit Treasury Stock $10,000 (the cost of the shares sold)
Credit Additional Paid-in Capital (if applicable) $2,500 (the excess of sale price over cost)
Par Value Method:
Under the par value method, treasury stock is recorded at its par value on the balance sheet.
When treasury stock is repurchased, the par value of the stock is debited to the treasury stock account, and any excess over par value is credited to additional paid-in capital.
Subsequent sale of treasury stock follows the same process as under the cost method, but the sale price is compared to the par value of the stock.
Example:
Let’s say a company repurchases 1,000 shares of its own stock with a par value of $1 per share for $20 per share. The entry to record the repurchase would be:
Debit Treasury Stock $1,000
Credit Common Stock (Par Value) $1,000
If the company later sells 500 of these shares for $25 per share, the entry to record the sale would be:
Debit Cash $12,500
Credit Treasury Stock $500 (the par value of the shares sold)
Credit Common Stock (Par Value) $500 (to reduce the common stock account)
Credit Additional Paid-in Capital $11,500 (the excess of sale price over par value)
These are simplified examples, and the actual accounting treatment may vary depending on the specific circumstances and applicable accounting standards.
