Common stock.

When a company such as Big City Dwellers issues 5,000 shares of its $1 par
value common stock at par for cash, that means the company will receive $5,000 (5,000 shares
$1 per share). The sale of the stock is recorded by increasing (debiting) cash and increasing
(crediting) common stock by $5,000.
General Journal
Date

Account Title and Description

Ref.

Debit

Credit

20X0

June 1

Cash

5,000

Common Stock

5,000

Sale of stock

If the Big City Dwellers sold their $1 par value stock for $5 per share, they would receive
$25,000 (5,000 shares $5 per share) and would record the difference between the $5,000 par
value of the stock (5,000 shares $1 par value per share) and the cash received as additional
paid-in-capital in excess of par value (often called additional paid-in-capital).
General Journal
Date

Account Title and Description

Ref.

Debit

Credit

20X0

June 1

Cash

Common Stock (5,000 $1)

25,000

5,000

Date

Account Title and Description

Ref.

Debit

Additional Paid-in-Capital

Credit

20,000

Sale of 5,000 shares of stock at $5 per share

When no-par value stock is issued and the Board of Directors establishes a stated value for legal
purposes, the stated value is treated like the par value when recording the stock transaction. If the
Board of Directors has not specified a stated value, the entire amount received when the shares
are sold is recorded in the common stock account. If a corporation has both par value and no-par
value common stock, separate common stock accounts must be maintained.
Preferred stock. The sale of preferred stock is accounted for using these same principles. A
separate set of accounts should be used for the par value of preferred stock and any additional
paid-in-capital in excess of par value for preferred stock. Preferred stock may have a call price,
which is the amount the issuing company could pay to buy back the preferred stock at a
specified future date. If Big City Dwellers issued 1,000 shares of its $1 par value preferred stock
for $100 per share, the entry to record the sale would increase (debit) cash by $100,000 (1,000
shares $100 per share), increase (credit) preferred stock by the par value, or $1,000 (1,000
shares $1 par value), and increase (credit) additional paid-in-capitalpreferred stock for the
difference of $99,000.
General Journal
Date

Account Title and Description

Ref. Debit

Credit

20X0

Preferred Stock (1,000 $1)

1,000

Date

Account Title and Description

Ref. Debit

Additional Paid-in-Capital (Preferred Stock)

Credit

99,000

Sale of 1,000 shares of preferred stock at $100 per share

Stock issued in exchange for assets or services

If corporations issue stock in exchange for assets or as payment for services rendered, a value
must be assigned using the cost principle. The cost of an asset received in exchange for a
corporation's stock is the market value of the stock issued. If the stock's market value is not yet
determined (as would occur when a company is just starting), the fair market value of the assets
or services received is used to value the transaction. If the total value exceeds the par or stated
value of the stock issued, the value in excess of the par or stated value is added to the additional
paid-in-capital (or paid-in-capital in excess of par) account. For example, The J Trio, Inc., a
start-up company, issues 10,000 shares of its $0.50 par value common stock to its attorney in
payment of a $50,000 invoice from the attorney for costs incurred by the law firm to help
establish the corporation. The entry to record this exchange would be based on the invoice value
because the market value for the corporation's stock has not yet been determined. The entry to
record the transaction increases (debits) organization costs for $50,000, increases (credits)
common stock for $5,000 (10,000 shares $0.50 par value), and increases (credits) additional
paid-in-capital for $45,000 (the difference). Organization costs is an intangible asset, included on
the balance sheet and amortized over some period not to exceed 40 years.
General Journal
Date

Account Title and Description

Ref. Debit

Credit

20X0

July 1 Organization Costs

Common Stock (10,000 $0.50)

50,000

5,000

Date

Account Title and Description

Additional Paid-in-Capital

Ref. Debit

Credit

45,000

Issue 10,000 shares to settle attorney's invoice for start-up costs

If The J Trio, Inc., an established corporation, issues 10,000 shares of its $1 par value common
stock in exchange for land to be used as a plant site, the market value of the stock on the date it is
issued is used to value the transaction. The fair market value of the land cannot be objectively
determined as it relies on an individual's opinion and therefore, the more objective stock price is
used in valuing the land.
The stock transactions discussed here all relate to the initial sale or issuance of stock by The J
Trio, Inc. Subsequent transactions between stockholders are not accounted for by The J Trio, Inc.
and have no effect on the value of stockholders' equity on the balance sheet. Stockholders' equity
is affected only if the corporation issues additional stock or buys back its own stock.

Treasury stock
Treasury stock is the corporation's issued stock that has been bought back from the stockholders.
As a corporation cannot be its own shareholder, any shares purchased by the corporation are not
considered assets of the corporation. Assuming the corporation plans to re-issue the shares in the
future, the shares are held in treasury and reported as a reduction in stockholders' equity in the
balance sheet. Shares of treasury stock do not have the right to vote, receive dividends, or receive
a liquidation value. Companies purchase treasury stock if shares are needed for employee
compensation plans or to acquire another company, and to reduce the number of outstanding
shares because the stock is considered a good buy. Purchasing treasury stock may stimulate
trading, and without changing net income, will increase earnings per share.
The cost method of accounting for treasury stock records the amount paid to repurchase stock as
an increase (debit) to treasury stock and a decrease (credit) to cash. The treasury stock account is
a contra account to the other stockholders' equity accounts and therefore, has a debit balance. No
distinction is made between the par or stated value of the stock and the premium paid by the
company. To illustrate, assume The Soccer Trio Corporation repurchases 15,000 shares of its $1
par value common stock for $25 per share. To record this transaction, treasury stock is increased
(debited) by $375,000 (15,000 shares $25 per share) and cash is decreased (credited) by a
corresponding amount. The entry looks like the following:
General Journal

Date

Account Title and Description

Ref.

Debit

Credit

20X0

Dec.3

Treasury Stock

375,000

Cash

375,000

Repurchase 15,000 shares at $25

In the balance sheet, treasury stock is reported as a contra account after retained earnings in the
stockholders' equity section. This means the amount reported as treasury stock is subtracted from
the other stockholders' equity amounts. Treasury shares are included in the number reported for
shares issued but are subtracted from issued shares to determine the number of outstanding
shares.
When treasury stock is sold, the accounts used to record the sale depend on whether the treasury
stock was sold above or below the cost paid to purchase it. If the treasury stock is sold above its
cost, the sale increases (debits) cash for the proceeds received, decreases (credits) treasury stock
for the cost paid when the treasury stock was repurchased, and increases (credits) additional
paid-in-capitaltreasury stock for the difference between the selling price and the repurchase
price. If Soccer Trio Corporation subsequently sells 7,500 of the shares repurchased for $25 for
$28, the entry to record the sale would be as shown:
General Journal
Date

Account Title and Description

Ref.

Debit

20X1

June 15 Cash (7,500 $28)

210,000

Credit

Date

Account Title and Description

Ref.

Debit

Credit

Treasury Stock (7,500 $25)

187,500

Additional paid-in-capital (treasury stock)

22,500

Record sale of 7,500 shares of treasury stock at $28

When the remaining 7,500 shares are sold, the entry to record the sale includes an increase
(debit) to cash for the proceeds received, a decrease (credit) to treasury stock for the repurchase
price of $25 per share or $187,500, and a decrease (debit) to additional paid-in-capital treasury
stock, if the account has a balance, for the difference. If the difference between cash received and
the cost of the treasury stock is greater than the additional paid-in-capitaltreasury stock
account, retained earnings is reduced (debited) for the remaining amount after the additional
paid-in-capitatreasury stock account balance is reduced to zero. If Soccer Trio Corporation
sells the remaining 7,500 shares of its treasury stock for $21, the entry to record the sale would
be as shown:
General Journal
Date

Account Title and Description

Ref.

Debit

20X1

June 25

Cash (7,500 $21)

157,500

Additional paid-in-capital (treasury stock)

22,500

Retained Earnings

7,500

Credit

Date

Account Title and Description

Treasury Stock (7,500 $25)

Ref.

Debit

Credit

187,500

Record sale of 7,500 shares of treasury stock at $21

If the Board of Directors decides to retire the treasury stock at the time it is repurchased, it is
cancelled and no longer considered issued. When this occurs, the common stock and additional
paid-in-capital accounts are decreased (debited) for the amounts recorded in these accounts when
the stock was originally issued and cash is decreased (credited) for the amount paid to repurchase
the stock. If the repurchase price is more than the original issue price, the difference is a decrease
(debit) to the additional paid-in-capitaltreasury stock account until its balance reaches zero.
Once the balance in the additional paid-in-capitaltreasury stock account reaches zero, or if
there is no such account, the difference is a decrease (debit) to retained earnings. If the
repurchase price is less than the original selling price, the difference increases (is credited to) the
additional paid-in-capital account.

Cite this article

Stock repurchase (or share buyback) is the reacquisition by a company of its own stock. In
some countries, including the U.S. and the UK, a corporation can repurchase its own stock by
distributing cash to existing shareholders in exchange for a fraction of the company's outstanding
equity; that is, cash is exchanged for a reduction in the number of shares outstanding.[1][2] The
company either retires the repurchased shares or keeps them as treasury stock, available for reissuance.
Under U.S. corporate law there are five primary methods of stock repurchase: open market,
private negotiations, repurchase 'put' rights, and two variants of self-tender repurchase: a fixed
price tender offer and a Dutch auction. In the late 20th and early 21st centuries, there was a sharp
rise in the volume of share repurchases in the United States: $5 billion in 1980 rose to $349
billion in 2005.[3]
It is relatively easy for insiders to capture insider-trading like gains through the use of "open
market repurchases." Such transactions are legal and generally encouraged by regulators through
safeharbours against insider trading liability.[1][2]
Contents
[hide]

1 Purpose
o

1.1 Tax-efficient distribution of earnings

2 Methods
o

2.1 Open-market

2.2 Fixed price tender

2.3 Dutch auction

3 Types
o

3.1 Selective buy-backs

3.2 Other types

4 External links

5 Further reading

6 Notes

[edit] Purpose

Companies making profits typically have two uses for those profits. Firstly, some part of profits
can be distributed to shareholders in the form of dividends or stock repurchases. The remainder,
termed stockholder's equity, are kept inside the company and used for investing in the future of
the company. If companies can reinvest most of their retained earnings profitably, then they may
do so. However, sometimes companies may find that some or all of their retained earnings
cannot be reinvested to produce acceptable returns.
Share repurchases are an alternative to dividends. When a company repurchases its own shares, it
reduces the number of shares held by the public. The reduction of the float,[4] or publicly traded
shares, means that even if profits remain the same, the earnings per share increase. Repurchasing
shares when a company's share price is undervalued benefits non-selling shareholders (frequently
insiders) and extracts value from shareholders who sell. There is strong evidence that companies
are able to profitably repurchase shares when the company is widely held by retail investors who
are unsophisticated and more likely to sell their shares to the company when those shares are
undervalued.[2] By contrast, when the company is held primarily by insiders and institutional
investors, who are more sophisticated, it is harder for companies to profitably repurchase shares.
[2]
Companies can also more readily repurchase shares at a profit when the stock is liquidly traded
and the companies' activity is less likely to move the share price.[2]
Financial markets are unable to accurately gauge the meaning of repurchase announcements,
because companies will often announce repurchases and then fail to complete them.[1]
Repurchase completion rates increased after companies were forced to retroactively disclose
their repurchase activity.[1] Normally, investors have more adverse reaction in dividend cut than
postponing or even abandoning the share buyback program. So, rather than pay out larger
dividends during periods of excess profitability then having to reduce them during leaner times,
companies prefer to pay out a conservative portion of their earnings, perhaps half, with the aim
of maintaining an acceptable level of dividend cover. Some evidence of this phenomenon for
United States firms is provided by Alok Bhargava who found that higher dividend payments
lower share repurchases though the converse is not true (Bhargava, 2010).

Aside from paying out free cash flow, repurchases may also be used to signal and/or take
advantage of undervaluation. If a firm's manager believes their firm's stock is currently trading
below its intrinsic value they may consider repurchases. An open market repurchase, whereby no
premium is paid on top of current market price, offers a potentially profitable investment for the
manager. That is, he may repurchase the currently undervalued shares, wait for the market to
correct the undervaluation whereby prices increases to the intrinsic value of the equity, and re
issue them at a profit. Alternatively, he may undertake a fixed price tender offer, whereby a
premium is often offered over current market price, sending a strong signal to the market that he
believes the firms equity is undervalued, proven by the fact that he is willing to pay above
market price to repurchase the shares.
Another reason why executives, in particular, may prefer share buybacks is that executive
compensation is often tied to executives' ability to meet earnings per share targets. In companies
where there are few opportunities for organic growth, share repurchases may represent one of the
few ways of improving earnings per share in order to meet targets. Thus, safeguards should be in
place to ensure that increasing earnings per share in this way will not affect executive or
managerial rewards. For example, Bhargava (2011) reports that stock options exercised by top
executives increase future share repurchases by U.S. firms. Higher share repurchases, in turn,
significantly lowered the Research and Development expenditures that are important for raising
productivity. Further, increasing earnings per share does not equate to increase in shareholders
value. This investment ratio is influenced by accounting policy choices and fails to take into
account the cost of capital and future cash flows, which are the determinants of shareholder
value.
Share repurchases avoid the accumulation of excessive amounts of cash in the corporation.
Companies with strong cash generation and limited needs for capital spending will accumulate
cash on the balance sheet, which makes the company a more attractive target for takeover, since
the cash can be used to pay down the debt incurred to carry out the acquisition. Anti-takeover
strategies therefore often include maintaining a lean cash position, and at the same time the share
repurchases bolster the stock price, making a takeover more expensive.
[edit] Tax-efficient distribution of earnings

Share repurchases also allow companies to covertly distribute their earnings to investors without
inflicting them with taxation. For example, if a company were to pay $100,000 in dividends on
one million shares or as 10 dividend per share, investors may incur tax upon this disbursement.
This means that instead of receiving 10 of earnings per share, they receive 8.5 (.10(1 .15))
at a 15% tax rate with 1.5 going to the government. An investor with 10 shares will receive 85.
As the company has to pay out this money the share price drops accordingly, from $10 to $9.90,
so the investor with 10 shares now has; $99 + 85 dividend, or $99.85.

Compare this with spending $100,000 buying back shares. This will remove 10,000 shares from
the market, leaving 990,000 shares at $10 each (($10,000,000 $100,000)/990,000 = $10). Now,
the investor with 10 shares still has $100, and the government receives no immediate tax
revenue. Ultimately, there should be no net change in investor wealth assuming a fully equity
financed business.
[edit] Methods
[edit] Open-market

The most common share repurchase method in the United States is the open-market stock
repurchase, representing almost 75% of all repurchases. A firm may or may not announce that it
will repurchase some shares in the open market from time to time as market conditions dictate
and maintains the option of deciding whether, when, and how much to repurchase. Open-market
repurchases can span months or even years. There are, however, daily buy-back limits which
restrict the amount of stock that can be bought over a particular time interval again ranging from
months to even years.
[edit] Fixed price tender

Prior to 1981, all tender offer repurchases were executed using a fixed price tender offer. This
offer specifies in advance a single purchase price, the number of shares sought, and the duration
of the offer, with public disclosure required. The offer may be made conditional upon receiving
tenders of a minimum number of shares, and it may permit withdrawal of tendered shares prior
to the offer's expiration date. Shareholders decide whether or not to participate, and if so, the
number of shares to tender to the firm at the specified price. Frequently, officers and directors are
precluded from participating in the tender offer. If the number of shares tendered exceeds the
number sought, then the company purchases less than all shares tendered at the purchase price on
a pro rata basis to all who tendered at the purchase price. If the number of shares tendered is
below the number sought, the company may choose to extend the offers expiration date.
[edit] Dutch auction

The introduction of the Dutch auction share repurchase in 1981 allows an alternative form of
tender offer. The first firm to utilize the Dutch auction was Todd Shipyards.[5] A Dutch auction
offer specifies a price range within which the shares will ultimately be purchased. Shareholders
are invited to tender their stock, if they desire, at any price within the stated range. The firm then
compiles these responses, creating a demand curve for the stock.[6] The purchase price is the
lowest price that allows the firm to buy the number of shares sought in the offer, and the firm
pays that price to all investors who tendered at or below that price. If the number of shares
tendered exceeds the number sought, then the company purchases less than all shares tendered at
or below the purchase price on a pro rata basis to all who tendered at or below the purchase
price. If too few shares are tendered, then the firm either cancels the offer (provided it had been

made conditional on a minimum acceptance), or it buys back all tendered shares at the maximum
price.
[edit] Types
[edit] Selective buy-backs

In broad terms, a selective buy-back is one in which identical offers are not made to every
shareholder, for example, if offers are made to only some of the shareholders in the company. In
the US, no special shareholder approval of a selective buy-back is required. In the UK, the
scheme must first be approved by all shareholders, or by a special resolution (requiring a 75%
majority) of the members in which no vote is cast by selling shareholders or their associates.
Selling shareholders may not vote in favour of a special resolution to approve a selective buyback. The notice to shareholders convening the meeting to vote on a selective buy-back must
include a statement setting out all material information that is relevant to the proposal, although
it is not necessary for the company to provide information already disclosed to the shareholders,
if that would be unreasonable.
[edit] Other types

A company may also buy back shares held by or for employees or salaried directors of the
company or a related company. This type of buy-back, referred to as an employee share scheme
buy-back, requires an ordinary resolution. A listed company may also buy back its shares in onmarket trading on the stock exchange, following the passing of an ordinary resolution if over the
10/12 limit.[7] The stock exchanges rules apply to on-market buy-backs. A listed company may
also buy unmarketable parcels of shares from shareholders (called a minimum holding buy-back).
This does not require a resolution but the purchased shares must still be cancelled.
[edit] External links