If a company has a cash surplus, it can invest the money in various projects or activities. In most cases, the goal is to increase the returns shareholders get from these projects. Sometimes, though, companies may also invest that money in their own shares. Treasury stock is a common concept in accounting.
Treasury stock can be a part of various financial statements, including cash flow statements. Before discussing its impacts on the report, it is crucial to understand what treasury stock is.
What is Treasury Stock?
Treasury stock refers to the shares a company buys back from its shareholders. These shares become a part of the company’s internal reserves. Sometimes, they may also fall into the “retired” category and are no longer available for trading. Companies may also use other names to present these shares. For example, repurchased, reacquired, retired, buyback stock, etc., are common names for treasury stock.
A company buys back its stock to reduce the number of its outstanding shares. This process can increase the company’s earnings per share (EPS) and improve financial performance. By doing so, the company can increase its share price in the market, allowing shareholders to make capital gains. However, companies may also buy back their shares for other reasons.
What is the accounting for Treasury Stock?
Treasury stock is a contra-equity account. Essentially, it means that it appears in the equity section of the balance sheet but has a negative effect. It does not increase equity, unlike other components that go under that heading. However, accounting standards require companies to present this stock separately on the balance sheet. This accounting treatment for treasury stock applies if the company intends to keep it for a future issue.
The above method for accounting for treasury stock also causes a profit or loss when reissuing the shares. These amounts become a part of the income statement. Companies may also retire these shares, meaning they are no longer available for issuing. In this case, companies use the constructive retirement method for accounting. Essentially, it involves reversing the journal entries for these shares.
What is the relationship between Treasury Stock and the Cash Flow Statement?
The above accounting treatment for treasury stock only discussed the impact on the balance sheet and income statement. However, the repurchase of stock also impacts the cash flow statement. The link between the two is obvious. When a company repays to reacquire treasury stock, it must happen through cash. This payment to shareholders for the repurchases impacts the cash flow statement.
Under the cash flow statement, the repurchase of shares may appear as a financing or investing activity. In most cases, it is the former. This transaction is an outflow of cash resources. Therefore, it reduces the net cash flows from those activities. In the cash flow statement, treasury stock appears as follows.
| Cash flow from financing activities | |
| Repurchase of shares | (000) |
| Net cash flows from financing activities | (000) |
If a company treats it as an investing activity, it can use the same presentation above under that section.
Conclusion
Treasury stocks are shares reacquired by a company from its shareholders. There are several reasons why companies reinvest in their own shares. Usually, this transaction impacts the balance sheet, the income statement, and the cash flow statement. With the cash flow statement, the repurchase of shares is a cash outflow that may appear under financing or investing activities.
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