Accounting: The Language of Business (Part 77)

Innovation is critical to the heartbeat of any successful corporation in the industrialized world.

Dinesh Paliwal

Corporations: Organization, Capital Stock Transactions, and Dividends (Part E)

by 

Charles Lamson

Treasury Stock Transactions

A corporation may buy its own stock to provide shares for resale to employees, for reissuing as a bonus to employees, or for supporting the market price of the stock. For example, General Motors bought back its common stock and stated that two primary uses of this stock would be for incentive compensation plans and employee savings plans. Such stock that a corporation has once issued and then reacquires is called treasury stock.

A commonly used method of accounting for the purchase and resale of treasury stock is the cost method. When the stock is purchased by the corporation, paid-in capital (the full amount of cash or other assets that shareholders have given a company in exchange for stock, par value plus any amount paid in excess) is reduced by debiting Treasury Stock for its cost (the price paid for it). The par value [Par value is the value of a single common share as set by a corporation's charter. It is not typically related to the actual value of the shares. In fact it is often lower. Any stock certificate issued for shares purchased shows the par value. When authorizing shares, a company can choose to assign a par value or not. (bdc.ca)] and the price at which the stock was originally issued are ignored. When the stock is resold, Treasury Stock is credited for its cost, and any difference between the cost and the selling price is normally debited or credited to Paid-in Capital from Sale of Treasury Stock.

To illustrate assume that the paid in capital of a corporation is as follows:

The purchase and sale of the treasury stock are recorded as follows:

As shown in the journal entry above, a sale of treasury stock may result in a decrease in paid-in capital. To the extent that Paid-in Capital from Sale of Treasury Stock has a credit balance, it should be debited for any decrease. Any remaining decrease should then be debited to the retained earnings account. 

Stock Splits

Corporations sometimes reduce the par or stated value of their common stock and issue a proportionate number of additional shares. When this is done, a corporation is said to have split its stock, and the process is called a stock split.

When stock is split, the reduction in par or stated value applies to all shares, including the unissued, issued, and treasury shares. A major objective of a stock split is to reduce the market price per share of the stock. This, in turn, should attract more investors to enter the market for the stock and broaden the types and numbers of stockholders.

To illustrate a stock split, assume that Rojek Corporation has 10,000 shares of $100 par common stock outstanding with a current market price of $150 per share. The board of directors declares a 5-for-1 stock split, reduces the par to $20, and increases the number of shares to 50,000. The amount of common stock outstanding is $1,000,000 both before and after the stock split. Only the number of shares and the par per share are changed. Each Rojek Corporation shareholder owns the same total amount of stock before and after the stock split. For example, a stockholder who owned 4 shares of $100 par stock before the split (total par of $400) would own 20 shares of $20 par stock after the split (total par of $400).

Since there are more shares outstanding after the stock split, we would expect that the market price of the stock would fall. For example in the preceding example, there would be five times as many shares outstanding after the split. Plus, we would expect the market price of the stock to fall from $150 to approximately $30 ($150 / 5).

Since a stock split changes only the par or stated value and the number of shares outstanding, it is not recorded by a journal entry. Although the accounts are not affected, the details of stock splits are normally disclosed in the notes to the financial statements. 

*WARREN, REEVE & FESS, 2005, ACCOUNTING, 21ST ED., PP. 491-492*

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