Treasury stock are shares a company authorizes but does not issue or issues but buys back from investors to reissue and not retire. Treasury stock transactions only decrease retained earnings and only under specific circumstances. Companies cannot increase retained earnings from the sale of treasury stock.
When a company authorizes and issues stock, the stocks bought by investors are the shares outstanding. If the company later decides to repurchase a significant number of shares outstanding from investors and it does not retire the stock and instead plans to reissue it, the stock becomes treasury stock. When a company buys back and retires a stock, they are effectively canceling the stock and the shares no longer have any market value. Companies also create treasury stock when they do not offer all authorized shares for sale to the public.
Reissue Price Greater than Original Price
When a company repurchases and reissues its stock, it debits the treasury stock contra-asset account and credits cash for the cost to repurchase the stock. When the company subsequently reissues the stock, if the reissue price is more than the original stock cost, the proceeds made from the sale of the reissued stock are credited to the additional treasury stock account. The company does not increase retained earnings from the proceeds of the sale by crediting the retained earnings account.
Reissue Price Less than Original Price
When the company buys back and reissues the stock for less than the original cost, the difference between the two prices is debited to the additional paid-in-capital account until it reaches a zero balance. The amount remaining after the account reaches zero is debited to retained earnings. It is only under these circumstances when treasury stock transactions affect retained earnings. If there were no remaining balance after the account reached zero, there would be no debit or decrease to retained earnings.
Retained Earnings Example
A company buys back 100 shares for $10 per share for a cost of $1,000. The company reissues the shares for $7 per share. The proceeds from the reissue sale is $700. The company currently has a credit balance in its paid in capital—treasury stock account of $100. In this case, the company credits the treasury stock account for $1,000. It credits the cash account for $700 from the proceeds of the reissue sale. It debits the paid-in-capital account for $100 because that is all that is in that account, leaving a remaining loss of $200 from the reissue sale. Since there isn’t enough money in the paid-in-capital account to debit the $200 remaining, the company debits retained earnings.