Reissuance of Treasury Stock Journal Entry
A company may buy back its own shares, also known as treasury stock. Treasury stock is a contra equity account recorded in the shareholders’ equity section of the balance sheet. It reduces the total number of outstanding shares on the open market and the shareholders’ equity by the amount paid for the stock.
There are three main reasons why companies buy back their own shares:
- To increase earnings per share (EPS). By buying back shares, a company can reduce the number of outstanding shares, which increases EPS. EPS is a key metric for measuring a company’s profitability and valuation.
- To increase the stock price. Buying back shares can create more demand for a company’s stock and reduce the supply, which can drive up the price. This can also signal to the market that the company believes its stock is undervalued and has confidence in its future prospects.
- To prevent a hostile takeover. By buying back shares, a company can reduce the risk of a hostile takeover by an outside party that wants to acquire a majority stake in the company. This can also help the company maintain its independence and control over its operations and strategy.
- Increasing EPS: When a company buys back shares, it reduces the denominator in the EPS calculation. This means that even if the company’s net income stays the same, its EPS will increase. This can make the company more attractive to investors, who may be willing to pay a higher price for its shares.
- Increasing the stock price: When a company buys back shares, it reduces the supply of those shares on the market. This can create more demand for the shares, which can drive up the price. Additionally, if a company buys back its shares when the price is below its intrinsic value, this can signal to investors that the company believes its stock is undervalued. This can also lead to an increase in the stock price.
- Preventing a hostile takeover: A hostile takeover occurs when an outside party acquires a majority stake in a company without the consent of the company’s management. By buying back shares, a company can reduce the risk of a hostile takeover by reducing the number of shares that are available to be acquired. This can make it more difficult for an outside party to acquire a majority stake in the company.
Re-issuance of Treasury Stock Journal Entry
The journal entry to issue common stock is debit cash, credit common stock & credit additional paid-in-capital.
| Account | Debit | Credit |
|---|---|---|
| Cash | XXX | |
| Common Stock | XXX | |
| Additional Paid In capital | XXX |
The journal entry to buyback common stock is debit treasury stock and credit cash.
| Account | Debit | Credit |
|---|---|---|
| Treasury Stock | XXX | |
| Cash | XXX |
Re-issuance of treasury stock journal entry is debit cash, credit treasury stock & credit additional paid-in-capital.
| Account | Debit | Credit |
|---|---|---|
| Cash | XXX | |
| Treasury Stock | XXX | |
| Additional Paid In Capital | XXX |
Draw Back of Stock Buyback
Stock buybacks can have a number of drawbacks for companies and shareholders.
- Reduced cash flow. When a company buys back its own shares, it reduces the amount of cash available for other purposes, such as investing in research and development, expanding into new markets, or paying off debt. This can have a negative impact on the company’s long-term growth prospects.
- Share price manipulation concerns. Some critics argue that companies use buybacks to artificially inflate their stock price and earnings per share (EPS). This can mislead investors and give the impression that the company is more profitable than it actually is.
- Diversion of funds from profitable investments. Companies that buy back their own shares may be diverting funds from more profitable investments that could enhance their long-term growth. This could hurt the company’s competitiveness and ability to generate shareholder value.
- Shortage of shares. If a company buys back too many of its own shares, it can create a shortage of shares on the market. This can make it difficult for investors to buy or sell the shares, which can reduce liquidity and trading volume.
- Signal of a lack of growth prospects. Some investors view stock buybacks as a sign that a company has run out of good ideas or growth prospects. This can hurt the company’s reputation and attractiveness to investors, customers, and employees.
- Risk and uncertainty. Stock buybacks involve risk and uncertainty for both the company and its shareholders. For example, the company may overpay for its shares or buy them at the wrong time, resulting in a loss of value or capital. Shareholders who sell their shares may miss out on future appreciation or dividends from the company. Shareholders who hold their shares may face higher volatility or tax implications from the buyback.