Treasury Stock and Retained Earnings

Treasury Stock Transactions

Definition: Treasury stock represents a company's own shares that it has repurchased from the open market.
Reason for Issuing Equity: Companies typically sell shares to bring in cash, as issuing equity provides cash flow.
Reason for Repurchasing Treasury Stock: Companies might repurchase shares for various reasons, such as increasing earnings per share or preventing hostile takeovers.
Par Value Irrelevance: The par value of common stock is irrelevant for treasury stock transactions.

Recording the Purchase of Treasury Stock

Principle: Treasury stock is recorded at its cost of acquisition.
Journal Entry Example (1,000 shares purchased at 15 each):
- Debit: Treasury Stock for the cost of the shares.
  - 1,000 ext{ shares} imes $15/ ext{share} = $15,000
- Credit: Cash, as the company is spending money to buy back its shares.
  - $15,000

Recording the Resale of Treasury Stock

Key Principle: When treasury stock is resold, it must be removed from the books at its original cost of acquisition, not its resale price.
Impact of Sale Price on "Additional Paid-in Capital - Treasury Stock": Any difference between the resale price and the original cost goes to an account called "Additional Paid-in Capital - Treasury Stock".
- If the resale price is higher than the original cost, "Additional Paid-in Capital - Treasury Stock" is credited (representing a "gain" on the transaction).
- If the resale price is lower than the original cost, "Additional Paid-in Capital - Treasury Stock" is debited (representing a "loss" on the transaction).
Journal Entry Example 1 (800 shares; acquired at 22, sold at 12):
- Debit: Cash (for the amount received from the sale).
  - 800 ext{ shares} imes $12/ ext{share} = $9,600
- Credit: Treasury Stock (to remove the stock at its original cost).
  - 800 ext{ shares} imes $22/ ext{share} = $17,600
- Debit: Additional Paid-in Capital - Treasury Stock (for the difference, as the sale price is lower than cost).
  - $17,600 ext{ (cost)} - $9,600 ext{ (cash received)} = $8,000
Journal Entry Example 2 (400 shares; acquired at 15, sold at 20):
- Debit: Cash (for the amount received from the sale).
  - 400 ext{ shares} imes $20/ ext{share} = $8,000
- Credit: Treasury Stock (to remove the stock at its original cost).
  - 400 ext{ shares} imes $15/ ext{share} = $6,000
- Credit: Additional Paid-in Capital - Treasury Stock (for the difference, as the sale price is higher than cost).
  - $8,000 ext{ (cash received)} - $6,000 ext{ (cost)} = $2,000

Retained Earnings

Definition: Retained earnings represent the cumulative net income of the company that has been retained for use in the business rather than paid out as dividends.
Factors Affecting Retained Earnings Balance:
- Net Income (increases retained earnings).
- Net Loss (decreases retained earnings).
- Dividends Paid (decreases retained earnings).
- Therefore, the balance is affected by net income, net loss, and dividends paid.
Calculating Retained Earnings Balance Over Multiple Periods:
- It's crucial to carry forward the ending balance from one period as the beginning balance for the next.
- Formula: ext{Beginning Retained Earnings} + ext{Net Income (or - Net Loss)} - ext{Dividends} = ext{Ending Retained Earnings}
- Example Calculation (Flowing Balance Through):
  - 2022:
    - Beginning Balance: 0
    - Net Income: + $1,200
    - Dividends: - $200
    - Ending Balance (2022): $0 + $1,200 - $200 = $1,000
  - 2023:
    - Beginning Balance: $1,000
    - Net Loss: - $500
    - Dividends: 0
    - Ending Balance (2023): $1,000 - $500 - $0 = $500
  - 2024:
    - Beginning Balance: $500
    - Net Income: + $2,300
    - Dividends: - $200
    - Ending Balance (2024): $500 + $2,300 - $200 = $2,600
- Alternative (Quick Method): Sum all net income/losses and subtract all dividends across the periods. This gives the final ending balance but doesn't show yearly progression.
Calculating Dividends from Retained Earnings Data:
- Given:
  - Beginning Retained Earnings: $150,000
  - Ending Retained Earnings: $200,000
  - Net Income: $160,000
- Using the formula: ext{Beginning RE} + ext{Net Income} - ext{Dividends} = ext{Ending RE}
- $150,000 + $160,000 - ext{Dividends} = $200,000
- $310,000 - ext{Dividends} = $200,000
- ext{Dividends} = $310,000 - $200,000 = $110,000
- Note: Information like cash flow or common stock issued is irrelevant for retained earnings calculation.

Shares Outstanding and Dividends

Issued Shares vs. Outstanding Shares:
- Issued Shares: The total number of shares a company has ever issued to the public.
- Outstanding Shares: The number of shares currently held by investors in the open market. This excludes treasury shares.
Calculation of Outstanding Shares:
- ext{Outstanding Shares} = ext{Issued Shares} - ext{Treasury Shares}
- Example: If 23,000 shares are issued and 4,000 are treasury shares:
  - ext{Outstanding Shares} = 23,000 - 4,000 = 19,000 ext{ shares}
Dividends and Treasury Shares: Dividends are not paid on treasury shares because they are not outstanding; they are held by the company itself.

Dividend Declaration

Declaration Date: The date on which the board of directors officially approves the payment of a dividend.
Journal Entry on Declaration Date:
- Debit: Dividends (an equity account, which eventually reduces Retained Earnings) for the total dividend amount.
- Credit: Dividends Payable (a liability account) for the total dividend amount.
Example (19,000 outstanding shares, 0.80 dividend per share):
- Total Dividend: 19,000 ext{ shares} imes $0.80/ ext{share} = $15,200
- Debit: Dividends for $15,200
- Credit: Dividends Payable for $15,200
Consistency: The journal entry (debit Dividends, credit Dividends Payable) is always the same for the declaration date; only the amount changes based on the number of outstanding shares and the dividend per share.