Reference no: EM133328422
Case: Can a company purchase its own stock on the open stock market? The answer is yes. Does the company get a discounted price when it purchases its own stock? The answer is no. Can the company force a shareholder to sell stock back to the company? The answer is no.
Why? Companies can use their own stock to purchase other companies, for incentive pay programs, and to protect itself from hostile takeovers.
Treasury stock is another general ledger account. It is a contra-equity account, which means it will have an opposite normal balance of an equity account. Treasury stock is a negative equity account because it is the amount of equity that has been taken off or out of the market.
When a company issues stock, assets and equity increase. However, we a company purchases treasure stock, both assets and equity decrease.
Let's remember we are talking about the company, after they have issued the stock. They buy it on the open market, just like any other buyer. So, the warning to us in the first part of the chapter is important to keep in mind with treasure stock.
"A company neither earns a profit nor incurs a loss when it sells its stock to, or buys its own stock from its stockholders."
What is the reasoning for the above statement? Why can't a company make a profit or suffer a loss when it buys or sells it own stock? It makes sense when we think about evaluating a company's profitability.
Treasury stock is the difference between the number of shares issued and the number of shares outstanding. If you have not already found it, be sure to read the section in our text chapter about authorized, issued, and outstanding quantities of stock.
For many companies, treasure stock is a very large amount
From the text, let's look at the size of the treasury stock compared to the rest of the equity. On the Home Depot Balance Sheet at the first of the chapter, the treasure stock is the largest number on all the line of equity. Please also note it is negative.
After the company has purchased the treasury stock, can it sell the shares back on the market? The answer is yes. This is where the cost of the shares become very important, so the cost of treasury stock share purchased must by tracked.
The price at which the company sells the shared of treasure stock is based on the market price of the stock when it is resold. When the company resells the treasury stock shares, it will of course receive cash. It also will reduce the amount of dollars in the treasury stock account. The difference between the selling price and the cost of the share goes into another "Paid in Capital" account, but the same account used when common stock is issued above par value. For treasure stock, we have a "Paid in Capital Treasure Stock" account.