Lesson 25 Flashcards
Why do corporations buy back their stock? 5 reasons.
- to provide tax efficient distributions of excess cash to shareholders
- to increase earnings per share and return on equity
- to provide stock for employee stock compensation contracts or to meet potential merger needs.
- to thwart takeover attempts or to reduce the number of stockholders
- to make a market in the stock
What is a leveraged buyout (LBO)
When companies choose to go private, they will buy back their outstanding stock. To accomplish this they will do a LBO, which the company borrows money to finance the stock repurchases.
Why isn’t treasury stock an asset?
Because that would imply that the corporation can own a part of itself. It cannot. It doesn’t become an asset it reduces the assets.
Treasury stock is essentially the same as what kind of capital stock?
unissued capital stock
What are the two methods of handling treasury stock?
- Cost method
- Par (stated) value method
What is the cost method when handling treasury stock?
results in debiting the Treasury stock account for the reacquisition cost and in reporting this account as a deduction from the total paid in capital and retained earnings on the balance sheet
What is the par (stated) value method
Records all transactions in treasury shares at their par value and reports the treasury stock as a deduction from capital stock only
What does outstanding stock mean?
the number of shares of issued stock that stockholders own
On September 14, 2017, Gayot Company reacquired 12,000 shares of its $1 par value common stock for $40 per share. Gayot uses the cost method to account for treasury stock.
What is the debit side of the journal entry to record the reacquisition of the stock?
Treasury Stock for $480,000
Correct. Under the cost method, when a company purchases treasury stock, it records the transaction at the price it paid in the Treasury Stock account. The journal entry for this transaction is: Debit: Treasury Stock $480,000, Credit Cash $480,000.
An analysis of stockholders’ equity of Hahn Corporation as of January 1, 2021, is as follows:
Common stock, par value $20; authorized 100,000 shares; issued and outstanding 90,000 shares: $1,800,000
Paid-in capital in excess of par: $900,000
Retained earnings: $760,000
Total: $3,460,000
Hahn uses the cost method of accounting for treasury stock and during 2021 entered into the following transactions:
Acquired 2,500 shares of its stock for $75,000.
Sold 2,000 treasury shares at $35 per share.
Sold the remaining treasury shares at $20 per share.
Assuming no other equity transactions occurred during 2021, what should Hahn report on December 31, 2021, as total additional paid-in capital?
$905,000
Correct. The difference in the cost of treasury stock and the subsequent sale is recorded in the Paid-in Capital account. In this case, Hahn purchased the original treasury stock at $30 per share ($75,000/2,500 shares). To record the subsequent sale of 2,000 shares, the $30 cost per share is posted to the treasury stock account and the $5 difference is posted to the paid-in capital account. The same is true when the remaining 500 shares of treasury stock are sold at a price of $10 per share lower than the original purchase price. Therefore, the balance of the paid-in capital account can be calculated by: $900,000 + (2000 shares x $5) - (500 shares x $10) = $905,000. Also, consider the journal entries for each of the transactions: Purchase of $2,500 shares of treasury stock: Debit Treasury Stock $75,000; Credit Cash $75,000; Sold 2,000 shares of treasury stock; Debit Cash $70,000; Credit Treasury Stock $60,000 (2,000 shares x $30 purchase price); Credit Paid-In Capital Excess of Par $10,000; Sold remaining 500 shares of treasury stock: Debit Cash $10,000; Debit Paid-In Capital Excess of Par $5,000; Credit Treasury Stock $15,000 (500 shares x $30 purchase price); The Balance of the Paid-In Capital Excess of Par account is: $900,000 + $10,000 - $5,000 = $905,000
When treasury stock is purchased for more than the par value of the stock and the cost method is used to account for treasury stock, what account(s) should be debited?
Treasury stock for the purchase price
Correct. Under the cost method, when a company purchases treasury stock, it records the transaction at the price it paid for the stock in the Treasury Stock account. The journal entry for this transaction is: Debit: Treasury Stock at the purchase price, Credit Cash.
“Gains” on sales of treasury stock (using the cost method) should be credited to which account?
Paid-in capital from treasury stock
Correct. Sales of treasury stock above and below cost of treasury stock are only recorded in the Paid-in Capital from Treasury Stock account. The capital stock account, the price at which shares are originally issued, is not affected. Gains & Losses occur when selling assets, however, treasury stock is not an asset.
