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What is Share Buyback?
A share buyback refers to a process that companies use to buy their outstanding shares in the market. The reason for doing so is to reduce the number of a company’s outstanding shares available on the market. It can provide several advantages to a company but may also have some disadvantages. Companies also need sufficient cash resources to buyback their shares from the market.
How do Share Buybacks work?
Share buybacks, also known as share repurchase, allow companies to buy their shares from the market. By doing so, companies can reduce their existing number of outstanding shares in the market. The repurchased shares become the company’s asset. It can also positively impact ratios such as the Earnings Per Share ratio.
When a company buys back its shares from the market, it invests in itself. Reducing the number of outstanding shares in circulation can decrease the supply of these shares. Therefore, it can result in higher share prices in the market. Most companies use share buybacks to increase their share prices, usually when a company’s management feels their shares are undervalued.
When a company’s management decides to purchase its shares back from the market, it may use one of two procedures. Firstly, the company may issue a tender offer for shareholders, allowing them to submit or tender their shares. Companies may also buy their shares on the open market for an extended period of time.
What is accounting for Share Buyback?
It is necessary to understand how share buybacks affect a company’s finances. Firstly, a share repurchase reduces the company’s outstanding number of shares. But it does not have a direct impact on the company’s equity balance. On the other hand, it also reduces its cash resources since it has to pay shareholders for these shares. Once a company rebuys its shares, they become the company’s treasury stock.
When a company purchases shares from the market, it can use the following accounting treatment to record the treasury stock.
| Dr | Treasury stock |
| Cr | Cash |
The amount used for the transaction will be equal to the cash the company pays for the shares. Later, the company has to decide whether to resell these shares or retire them. The subsequent account treatment will differ according to the decision made by the company. However, the above accounting treatment will suffice to record the repurchase.
Example
A company, Blue Co., has 120,000 outstanding shares in the market. The company’s management decides to repurchase 20,000 of these shares. Therefore, Blue Co. has to record the transaction in its accounting system. The company must pay $10 to repurchase each share. The accounting treatment for this transaction will be as follows.
| Dr | Treasury stock | $200,000 |
| Cr | Cash | $200,000 |
The shares will stay in Blue Co.’s possession until the management makes a decision about them. As mentioned, it can choose to either resell them in the future or retire them. In both circumstances, the accounting treatment will differ.
Conclusion
A share buyback is a process used by companies to repurchase their stocks from the market. There are several reasons why companies may choose to repurchase their shares. The accounting for share buyback is straightforward. Companies have to record the repurchased shares as treasury stock and reduce their cash balance in exchange.
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