Companies obtain finance from different sources to conduct their operations. One of the most common of these sources includes equity. Usually, it involves issuing common stock in exchange for funds received from shareholders. This finance source represents a long-term solution for companies. However, it may also involve various costs like paying dividends.
While companies usually issue shares, they may also decide to repurchase them. This transaction falls under the treasury stock process. Similarly, companies may refer to it as the repurchase of shares or share buyback.
Regardless of the terms used, the process will stay the same. The accounting for the repurchase of shares may be complex. Before discussing that, it is crucial to understand how the process works.
What Does Repurchase of Shares mean?
The repurchase of shares refers to a transaction where companies reacquire their shares. Usually, they gather their previously issued stock from the market. The company repays the holders the market value of those shares to reacquire them.
Then, it classifies those shares under treasury stock. In some cases, companies may also deal with shareholders directly to repurchase their shares.
The repurchase of shares reduces the number of shares outstanding for a company. This process decreases the total shares in circulation within the market. Consequently, it usually acts as a vehicle to increase share prices.
However, the repurchase of shares can also have an adverse impact. It occurs when the market views the reacquisition adversely.
Usually, companies repurchase their shares when they have surplus cash. Companies then use that cash to reacquire their stocks from the market. However, this process occurs after a strategic decision from the management.
On top of that, companies may also have other uses for surplus, for example, investing in projects. Companies may have various reasons to choose the repurchase strategy.
Overall, the repurchase of shares refers to a process where companies reacquire their shares. Usually, they do so through the market. In some cases, companies may also repurchase them from shareholders directly.
Once companies reacquire those shares, they classify them under treasury stock. The accounting treatment for this stock is straightforward. However, some factors may impact how companies perform that treatment.
What is the accounting treatment for the Repurchase of Shares?
The accounting treatment of the repurchase of shares involves recording treasury stock in the financial statements. It represents a contra equity account in the balance sheet. Essentially, it implies that it is a negative equity balance.
Although it may not classify as a stock, companies must record it under the equity section. The repurchase of shares can have many impacts on the financial statements beyond that.
The accounting for the repurchase of shares can occur under two different methods. The first is the cost method. Under this method, companies record the entire amount of the repurchase of the treasury stock account.
On the other hand, companies can also use the constructive retirement method. However, this method applies when the company assumes it will not reissue the repurchased stock.
Subsequently, when companies reissue these stocks, the accounting may differ again. Under the cost method, the resale of treasury stock is straightforward. It involves using the cost of that stock to offset any cash received.
Any extra amount goes into the additional paid-in capital account. However, companies may still retire those shares despite accounting for them under the cost method.
Under the constructive retirement method, companies only record the repurchase of shares initially. This process involves removing the balance from the ordinary stock account. However, this entry will only include the par value of the underlying shares.
Any additional amount goes into the share premium account. However, that amount still gets limited to the original value recorded in that account. Any extra balance gets debited to the retained earnings account.
Under the constructive retirement method, the reissue of treasury stock is different. Companies use the same accounting treatment they do for traditional issues. Essentially, it is crucial to do so since the company does not record treasury stock in this method.
Overall, the accounting for the repurchase of shares differs based on the accounting treatment for the transaction. Companies can choose which approach they want to use.
What are the journal entries for Repurchase of Shares?
As stated above, the journal entries for the repurchase of shares occur under two methods. Usually, it involves the cost and constructive retirement method. Based on the approach used, the journal entries will also differ. Therefore, it is crucial to study them individually.
The Cost Method
Under the cost method, companies record the cost of the treasury stock for the entire amount. This method is one of the most commonly used among companies. When a company repurchases its shares, it can use the following journal entries to record it under the cost method.
| Date | Particulars | Dr | Cr |
| Treasury stock | XXXX | ||
| Cash or Bank | XXXX |
If the company reissues these shares, it must reverse the amount in the treasury stock. However, companies may receive a higher amount than they originally paid for the treasury stock. Therefore, they must record the extra amounts into the additional paid-in capital account. The journal entries will be as follows.
| Date | Particulars | Dr | Cr |
| Cash or Bank | XXXX | ||
| Additional paid-in capital | XXXX | ||
| Treasury stock | XXXX |
Alternatively, companies can choose to retire the shares as well. This approach will require them to remove the balance from the share capital and premium accounts.
However, the par value of the shares will go into the former account. Any extra amounts go into the additional paid-in capital account. For that transaction, the journal entries will be as follows.
| Date | Particulars | Dr | Cr |
| Ordinary stock (Par value) | XXXX | ||
| Additional paid-in capital | XXXX | ||
| Treasury stock | XXXX |
The Constructive Retirement Method
Under the constructive retirement method, companies record the repurchase directly. In this approach, they do not anticipate reissuing the shares. Therefore, it is more straightforward than the cost method of accounting for the repurchase of shares. When companies repurchase shares, they use the following journal entries.
| Date | Particulars | Dr | Cr |
| Ordinary stock (Par value) | XXXX | ||
| Additional paid-in capital | XXXX | ||
| Retained earnings | XXXX | ||
| Treasury stock | XXXX |
Under this method, the par value of the shares goes into the ordinary stock account. Any amount originally recorded into the additional paid-in capital account may also get reversed.
However, it assumes the company pays the same amount it received for the shares. If the company makes a higher payment, the additional amount will go into the retained earnings account.
Example
A company, ABC Co., decides to repurchase 10,000 of its shares. The par value of those shares is $10. However, ABC Co. pays $15 per share to repurchase them.
The company chooses the cost method of accounting for the repurchase of shares. ABC Co. records the transaction using the following journal entries.
| Date | Particulars | Dr | Cr |
| Treasury stock (10,000 shares x $15) | $150,000 | ||
| Cash or Bank | $150,000 |
ABC Co. reissues these shares at $20 per share after a year. Therefore, the company receives $200,000 through the bank. ABC Co. records the transaction using the following journal entries.
| Date | Particulars | Dr | Cr |
| Bank | $200,000 | ||
| Treasury stock | $150,000 | ||
| Additional paid-in capital | $50,000 |
Conclusion
The repurchase of shares is known as treasury stock. It occurs when companies decide to reacquire their stocks from shareholders. Usually, it occurs when companies have a cash surplus.
However, other reasons may also exist for this strategic decision. The accounting treatment for the repurchase of shares falls under two methods. These include the cost and constructive retirement methods.
