to the Additional Paid-in Capital: Common Stock account. that no gain or loss is recognized on treasury stock transactions, even when the shares are reissued price .above .or below cost. A corporation earns profits by selling goods and services to outsiders, not by-issuing or reissuing shares of its own capital stock..
When treasury shares are reissued at a price above cost, the corporation receives from the new stockholder an amount of. paid-in. capital that is larger than the reduction in stockholders’ equity that occurred when the corporation acquired t tie treasury shares,if treasury shares are reissued at a price below cost, the corporation ends up witlessness paid-in capital as a’ result of the purchase and reinsurance of the shares.
Thus any change sin .stockholders’ equity resulting from treasury stock transactions are regarded as changes in paid-in capital and are not included ill the measurement of net income,Restriction of Retained Earnings for Treasury Stock Owned Purchases of treasury stock; like cash dividends, are distributions of assets to the stockholders ‘in the corporation.
Many.states have a legal-requirement that distributions to stockholders (including purchases. of treasury stock) cannot exceed the balance in the Retained Earnings account. Therefore, retained earnings usually. are restricted by an amount equal to the cost of any’ shares held in the treasury” Stock Buyback Programs in past years, most treasury stock transaction, involved relatively small dollar amounts, Hence, the topic was not of much importance to investors or other users of financial statements, Late in 1987,howsoever, many corporations initiated large buyback programs. in’ which they repurchased huge amounts of their own common stock.”
A result of these programs, treasury stock has become a very material item in the balance sheets of many corporations,,”On October 19, 1987, a date known as Black , stocks around ‘the world suffered the largest one-day decline in history, Within hours of the market’s close on Black Monday, many large.corporations announced their intention to enter the market and spend hundreds 01 millions of dollars repurchasing their own shares, In ·the opinion of the authors, these announcements helped stabilize the investment markets and avoid a possible stock market collapse;These large; buyback programs serve. several purposes.
First, by. casting demand for the company’s stock in the marketplace, these programs tend to increase the market value , of the shares. Also. reducing the number of shares outstanding usually increases earnings per share: When stock prices are low. some ‘companies find that they can increase earnings. per share by a greater’ amount through repurchasing shares than through expanding business operations.
At;.noted previously; transactions between the corporation and Its stockholders are classified in the statement of cash flows as financing activities. Accordingly, the purchase and re-issuance of treasury stock result in cash flows from financing activities. When .treasury stock’s purchased, a financing cash outflow is reported in the statement of cash flows. When treasury stock is reissued the:amount of cash received is reported asa financing cash Inflow in the statement of cash flows. Because-treasury stock transactions do not give rise to gains or losses, they have n.o effect on the corporation’s net Income Any difference between the purchase price of the treasury stock and the cash received whim It is reissued is reported as an increase or decrease In the corporation’s paid-in capital.