What impact does the purchase of treasury stock have on the accounting equation?

Other times, a company may buy back public shares as part of a reorganization that contemplates the company “going private” or delisting from some particular stock exchange. Further, a company might buy back shares and in turn issue them to employees pursuant to an employee stock award plan.

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Whatever the reason for a treasury stock transaction, the company is to account for the shares as a purely equity transaction, and “gains and losses” are ordinarily not reported in income. Procedurally, there are several ways to record the “debits” and “credits” associated with treasury stock, and the specifics can vary globally. The “cost method” is generally acceptable. Under this approach, acquisitions of treasury stock are accounted for by debiting Treasury Stock and crediting Cash for the cost of the shares reacquired:

The effect of treasury stock is very simple: cash goes down and so does total equity by the same amount. This result occurs no matter what the original issue price was for the stock. Accounting rules do not recognize gains or losses when a company issues its own stock, nor do they recognize gains and losses when a company reacquires its own stock. This may seem odd, because it is certainly different than the way one thinks about stock investments. But remember, this is not a stock investment from the company’s perspective. It is instead an expansion or contraction of its own equity.

Treasury Stock is a contra equity item. It is not reported as an asset; rather, it is subtracted from stockholders’ equity. The presence of treasury shares will cause a difference between the number of shares issued and the number of shares outstanding. Following is Embassy Corporation’s equity section, modified (see highlights) to reflect the treasury stock transaction portrayed by the entry.

If treasury shares are reissued, Cash is debited for the amount received and Treasury Stock is credited for the cost of the shares. Any difference may be debited or credited to Paid-in Capital in Excess of Par.

Did you learn?What is treasury stock, and where is it positioned on a balance sheet?Prepare journal entries for treasury stock transactions, including reissuances.Do gains and losses arise on treasury stock transactions?Can retained earnings be increased or decreased as a result of treasury stock transactions?

In our examples below, we show how a given transaction affects the accounting equation for a corporation. We also show how the same transaction will be recorded in the company's general ledger accounts.

In addition, we show the effect of each transaction on the balance sheet and income statement. (Our examples assume that the accrual basis of accounting is being followed.)

In the examples that follow, we will use the following accounts:

• Cash
• Accounts Receivable
• Equipment
• Notes Payable
• Accounts Payable
• Common Stock
• Retained Earnings
• Treasury Stock
• Service Revenues
• Advertising Expense
• Temp Service Expense

(To view a more complete listing of accounts for recording transactions, visit our Explanation of Chart of Accounts.)

We also assume that the corporation is a Subchapter S corporation in order to avoid the income tax accounting that would occur with a "C" corporation. (In a Subchapter S corporation the owners are responsible for the income taxes instead of the corporation.)

Corporation Transaction C1

Let's assume that members of the Ott family form a corporation called Accounting Software, Inc. (ASI). On December 1, 2021, several members of the Ott family invest a total of $10,000 to start ASI. In exchange, the corporation issues a total of 1,000 shares of common stock. (The stock has no par value and no stated value.) The effect on the corporation's accounting equation is:

As you see, ASI's assets increase by $10,000 and stockholders' equity increases by the same amount. As a result, the accounting equation will be in balance.

The accounting equation tells us that ASI has assets of $10,000 and the source of those assets was the stockholders. Alternatively, the accounting equation tells us that the corporation has assets of $10,000 and the only claim to the assets is from the stockholders (owners).

This transaction is recorded in the asset account Cash and in the stockholders' equity account Common Stock. The general journal entry to record the transaction is:

After the journal entry is recorded in the accounts, a balance sheet can be prepared to show ASI's financial position at the end of December 1, 2021:

The purpose of an income statement is to report revenues and expenses. Since ASI has not yet earned any revenues nor incurred any expenses, there are no amounts to be reported on an income statement.

Corporation Transaction C2.

On December 2, 2021, ASI purchases $100 of its stock from one of its stockholders. The stock will be held by the corporation as Treasury Stock. The effect of the accounting equation is:

The purchase of its own stock for cash causes ASI's assets to decrease by $100 and its stockholders' equity to decrease by $100.

This transaction is recorded in the asset account Cash and in the stockholders' equity account Treasury Stock. The accounting entry in general journal form is:

Since the transactions of December 1 and December 2 were in balance, the sum of both transactions should also be in balance:

The totals indicate that ASI has assets of $9,900 and the source of those assets is the stockholders. The accounting equation also shows that the corporation has assets of $9,900 and the only claim against the assets is the stockholders' claim.

The December 2 balance sheet will communicate the corporation's financial position as of midnight on December 2:

The purchase of a corporation's own stock will never result in an amount to be reported on the income statement.

How does the purchase of treasury stock affect the basic accounting equation?

What is the effect of the purchase of treasury stock?

Does purchasing treasury stock increase assets?

When treasury stock is purchased with cash what is the impact on the balance sheet equation?