Discuss the accounting for treasury shares

Answer 1

ACCOUNTING FOR TREASURY SHARES

U.S. GAAP and IFRS on accounting for repurchases and reissuances of treasury shares follow the principle that a corporation does not report a gain or loss on transactions involving its own shares. Even though the firm may sell (technically, reissue) the shares for more, or less, than their acquisition cost, accounting does not report the economic gain, or economic loss, as a component of accounting income. The required accounting views treasury stock purchases and sales as financing, not operating, transactions and therefore debits (for economic losses) or credits (for economic gains) the contributed capital accounts for the adjustments for reissue of treasury shares. The amounts bypass net income, other comprehensive income and Accumulated Other Comprehensive Income, and often Retained Earnings (depending on the specific accounting method used).

U.S. GAAP provides for three approaches to the accounting for treasury shares:

1 . The cost method.
2 . The par value method.
3 . The constructive retirement method.

All three approaches reduce shareholders' equity but the specific accounts affected differ. All
three approaches are consistent with IFRS, which requires only that firms reduce shareholders' equity for the acquisition cost of the shares and report no gain or loss on treasury share transactions.

Cost Method for Repurchased Shares

When a firm reacquires common shares under the cost method, it debits the Treasury Shares—Common account with the total amount paid to reacquire the shares.

The Treasury Stock—Common account has a debit balance and therefore reduces total
shareholders' equity.

Par Value Method for Repurchased Shares

When a firm uses the par value method to account for treasury shares, it debits the Treasury Stock—Common account for the par value of the repurchased shares, debits Additional Paid-In Capital for the difference between the original issue price of the shares and par value, and plugs Retained Earnings for any difference between the repurchase price ($50 in this case) and the original issue price ($40 in this case). The par value method requires specific identification of the date and initial proceeds of the shares repurchased, which is why firms seldom use this method.

Constructive Retirement Method for Repurchased Shares

The constructive retirement method differs from the par value method in only one way: the debit is to Common Stock, not Treasury Stock—Common. Firms use this method when management and the governing board do not intend to reissue shares within a reasonable amount of time or when jurisdiction-specific corporation laws define reacquired shares as retired shares.

In some cases, particularly when the reissue results from the exercise of employee stock
options, the amount paid by the firm to reacquire the treasury shares exceeds the subsequent
reissue price. If the firm uses the cost method, it debits the balance to Additional Paid-
In Capital so long as that account has a sufficiently large credit balance. To the extent the
required debit exceeds the credit balance in the Additional Paid-In Capital account, the firm
reduces that account to zero and debits the excess to Retained Earnings. If the firm applied
the par value method or the constructive retirement method, it is unlikely that the reissue
price would be so low as to require a debit to Additional Paid-In Capital (that is, the reissue
price is almost surely greater than par value).