What are Treasury Stocks?
Treasury stocks are shares of a company’s own stock that have been repurchased by the company and held in its treasury. Although treasury stocks are not popular as other types of stocks, they play an important role in the financial management of companies.
In this blog, we will examine what treasury shares are, why companies repurchase them, and how they affect financial statements. Moreover, we will also tell you about how you can invest in the share market via smallcase.
So, let’s dive in!
Treasury Stock Meaning
Treasury stock, also known as “reacquired shares,” are stocks that a company has previously issued and then repurchased. These shares are kept in the company’s treasury rather than being retired, meaning they are not available for public trading.
Companies can acquire treasury stocks through various methods, such as open market purchases or employee stock option plans (ESOPs). These stocks are helpful in:
- Boosting stock prices
- Preventing hostile takeovers
- Compensating employees
- Providing liquidity for stockholders.
What is the treasury stock method?
The treasury stock method is a way of calculating the impact of dilutive securities. This includes stock options, warrants, and convertible securities on the earnings per share (EPS) of a company.
The method assumes that the proceeds from the exercise of these securities are used to repurchase shares of the company’s own stock in the open market which are then held as treasury stocks.
The number of additional shares that can be purchased with the proceeds from the dilutive securities is determined by dividing the proceeds by the average market price of the company’s stock during the reporting period. This additional number of shares is added to the outstanding shares for the EPS calculation.
Here is the Treasury Stock Method formula:
Additional Shares Outstanding = [Gross “In-the-Money” Dilutive Securities] – [Repurchased Shares]
*Additional shares outstanding = n – (n x K / P)
*Additional shares outstanding = n x (1 – K / P)
- Repurchased Shares = option proceeds
- n = shares from exercised options and warrants
- K = average exercise share price (strike price)
- P = Average share price for the reporting period
Companies widely use the treasury stock method to calculate the effect of dilutive securities on EPS in their financial reports.
What is the cost method of treasury stock?
The cost method of treasury stock accounting involves recording treasury stock at its cost of acquisition and making necessary adjustments to reflect changes in the company’s equity accounts.
This method accounts for treasury stock purchases that are made with cash and are recorded at the time of purchase. Treasury stock is a contra-equity account under the cost method. Its debit amount is deducted from the overall equity of the company to determine the net equity balance.
The cost method is simple to use and provides a clear picture of the company’s equity position, making it a popular choice for many businesses.
How are Treasury Stocks acquired?
A few ways to acquire treasury shares are as follows:
1. Purchase through the Open Market
The most common method to acquire treasury stock is to purchase them from the open market. Where a company buys back its own shares from the public. This allows the company to control the number of outstanding shares and boost the value of the remaining shares.
2. Purchase through Tender Offer
Another way to acquire treasury stock is through a tender offer. Where a company offers to purchase shares directly from its shareholders at a premium price. This can be a way for a company to quickly acquire a large number of shares and consolidate ownership.
3. Purchase through Employee Stock Options Plan (ESOPs)
Companies also acquire treasury stock through employee stock option plans (ESOPs). In this case, the company issues stock options to its employees. When the employees exercise those options, the company purchases shares on the open market to fulfil the option.
Reasons for Acquiring Treasury Stocks
Acquiring treasury stocks is a common practice for companies for various reasons, including:
1. Boosting stock prices
Companies may buy back their own shares to increase demand for their stock and thereby boost their stock prices.
2. Preventing hostile takeovers
When a company acquires a significant number of its own shares, it reduces the number of shares available for purchase by other entities. This makes it more difficult for a hostile takeover to occur.
3. Compensating employees
Companies may use treasury stock to compensate employees in their employee stock ownership plans (ESOPs).
4. Providing liquidity for stockholders
Buying back shares will reduce the number of shares available for trading in the open market. This can increase the value of the remaining shares. And provide liquidity for existing stockholders who may want to sell their shares.
Impact of Treasury Stocks on Financial Statements
Treasury stock has a significant impact on the financial statements of a company. This includes the balance sheet, income statement, and cash flow statement.
On the balance sheet, treasury stocks are reported as a reduction in the total shareholders’ equity. The cost of acquiring treasury stock is deducted from the total shareholders’ equity. This results in a decrease in the company’s net worth.
This is because treasury shares are considered as a reduction in the number of outstanding shares, hence the company’s ownership.
On the income statement, treasury stocks do not have a direct impact on the revenue or expenses of the company. However, if the company decides to resell the treasury stocks, any gains or losses on the sale will be recorded in the income statement as a non-operating item.
Cash Flow Statement
The acquisition of treasury shares is recorded as a cash outflow from the financing activities section. The sale of treasury stocks, on the other hand, is recorded as a cash inflow in the financing activities section.
Is treasury stock an asset?
Yes, treasury stock is considered an asset on a company’s balance sheet. This is because it represents shares that the company purchases shareholders and now holds in its own possession. However, unlike other assets such as property, plant, and equipment, treasury stock has no productive use or potential for generating revenue.
Are dividends paid on treasury stocks?
No, companies do not pay dividends on treasury stocks. Since the company owns these stocks, it cannot receive dividends on them. Additionally, paying dividends on treasury stock would essentially be transferring money from one account to another within the same company, which does not make sense. Therefore, companies do not pay dividends on treasury stock.
Difference between Cash Dividends and Treasury Stocks Purchases
Cash dividends and treasury stock purchases are two separate actions that a company takes. Cash dividends are a distribution of profits to shareholders, typically paid out in cash. Treasury stock purchases, on the other hand, involve a company buying back its own shares on the open market or through other means.
Final Thoughts on Treasury Stocks
Treasury stock can be an important tool for companies to manage their finances and achieve their strategic goals. These stocks help boost stock prices, prevent hostile takeovers, compensate employees, and provide liquidity for stockholders.
Moreover, investing in the stock market via smallcase can be a convenient and cost-effective way for you to gain exposure to a diversified portfolio of stocks.
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