AN EXPLANATION OF TREASURY STOCK ON A BALANCE SHEET
Treasury stock occurs when outstanding stock is re-purchased by the Company. The most common occurrence results from departures, retirement and death of owner.
When stock is “retired” into Treasury Stock cash or some form of debt is used to pay for the stock, the diminishment of the cash asset or the addition of a liability to pay for the stock requires an entry into Equity that diminishes it. For that reason, Treasury Stock is always a negative entry to Equity.
If an agency has 1000 shares of outstanding stock worth $1,000,000 and 500 shares are retired into Treasury Stock, some combination of $1,000,000 in cash and/or debt is used to pay for the stock being retired and a negative entry is made into Equity as Treasury Stock (-$500,000). That negative amount stays in Equity forever, lowering the Tangible Net Worth of the agency (defined as Total Equity less any intangible assets) and its value as a Company. It also means that the 500 remaining shares become 100% of the outstanding shares available. The remaining owners find their ownership percentage increasing accordingly.
The only exception is when new owners are selected and the agency selects to provide the stock from Treasury Stock instead of from the holdings of the remaining owners. In that case, the agency’s Tangible Net Worth rises dollar for dollar by the value of the Treasury Stock brought out of retirement since the new owner will enhance the agency’s assets through cash and loans payable. The action of re-issuing stock from Treasury Stock dilutes the holdings of the current owners but doesn’t change the value of their stock.
Example: Owner A has 250 shares and Owner B has 250 shares each worth $250,000 with 500 shares in Treasury Stock. The owners each own 50% of the Company.
Owner C is adopted by buying 250 shares from Treasury Stock. He pays $250,000 to the agency (in cash or a combination of cash and loan payable). The Tangible Net Worth rises by $250,000 (to -$250,000 from -$500,000) allowing each owner a 33% interest with 250 shares, each worth $250,000.
One major difference between stock and asset purchases is the amortization availability for asset purchases (amortized at 1/15th (.0666) per year for 15 years). For all practical purposes you may write off 1/15th of the value of the asset each year and save taxes by lowering net income. Stock purchases are not normally amortizable.
It is important to understand your Balance Sheet. It is critical for owners, new and old, to understand how their stock works and why it is advisable (sometimes) to retire stock into Treasury Stock or bring shares out of retirement to add stockholders. If you have questions about Treasury Stock and how and when to use it, call us at 800-779-2430.