Treasury Shares

Treasury shares are shares a corporation issued, later reacquired, and still holds uncancelled. New York’s Business Corporation Law states the status directly: treasury shares are issued shares, but not outstanding shares, and are not assets (N.Y. Bus. Corp. Law § 102(a)(14)). Accounting rules call the same holding treasury stock, and the two terms name one thing.

Issued Shares, Outstanding Shares, and What a Buyback Changes

Whether a repurchase undoes the issuance is a question of state law. Where the shares may be retained uncancelled they stay issued, so the issued count does not move, while the outstanding count falls by whatever went into treasury (N.Y. Bus. Corp. Law § 515(b)).

Other states set the opposite default, and there a repurchase does undo the issuance. In Washington a corporation may acquire its own shares and shares so acquired constitute authorized but unissued shares (RCW 23B.06.310(1)). Virginia reads the same way, since shares a corporation acquires constitute authorized but unissued shares of the same class (Va. Code § 13.1-652(A)). Nothing is retained uncancelled there, so no treasury share arises at all and the issued count does move.

What follows where treasury shares do exist is statutory rather than convention. Treasury shares are not entitled to vote and are not counted in determining the total number of outstanding shares (N.Y. Bus. Corp. Law § 612(b)). Delaware reaches the same result on the vote: shares of a corporation’s capital stock are neither entitled to vote nor counted for quorum purposes if they belong to the corporation (8 Del. C. § 160(c)). Dividends are declared and paid on a corporation’s outstanding shares (N.Y. Bus. Corp. Law § 510(a)), which leaves shares held in treasury out of the distribution.

So the rights a stockholder holds travel with outstanding status, not with issuance. A stock split is the useful contrast: it changes the share count with no consideration passing, while a repurchase cuts the outstanding count by paying for the shares.

How Treasury Shares Appear in the Equity Section

They are a deduction inside equity, never an asset. Where stock is acquired for purposes other than retirement, or where its ultimate disposition has not yet been decided, the cost of the acquired stock may be shown separately as a deduction from the total of capital stock, capital surplus, and retained earnings (Accounting Research Bulletin No. 43, Chapter 1, Section B, paragraph 7(b)). New York’s statute settles the asset question in the same direction, since treasury shares are not assets (N.Y. Bus. Corp. Law § 102(a)(14)).

That makes the account contra-equity: its balance reduces the equity section instead of adding to it, so total stockholders’ equity is struck after the deduction. The deduction comes off the ordinary equity captions, common stock among them. The residual it sits inside is worked through in owner’s equity, which also names the Schedule L line an S corporation return deducts it on.

State law can override that treatment. Laws of some states govern the circumstances under which a corporation may acquire its own stock and prescribe the accounting treatment for it, and where those requirements are at variance with the bulletin’s paragraph 7, the accounting should conform to the applicable law. Where state law restricts the availability of retained earnings for payment of dividends, or has other effects of a significant nature, those facts should be disclosed (Accounting Research Bulletin No. 43, Chapter 1, Section B, paragraph 11A).

The Cost Method and the Par Value Method

Two treatments are allowed for stock acquired for purposes other than retirement.

Under the cost method the block is carried at what was paid for it, and that cost is the amount deducted inside equity. The original issuance entries are left where they are (Accounting Research Bulletin No. 43, Chapter 1, Section B, paragraph 7(b)).

Under the par value method the shares are instead accorded the accounting treatment appropriate for retired stock, even though nothing has been formally retired. That treatment splits by direction. An excess of purchase price over par or stated value may be allocated between capital surplus and retained earnings, though the portion allocated to capital surplus should be limited to a ceiling, and alternatively the whole excess may be charged entirely to retained earnings. An excess of par or stated value over purchase price should be credited to capital surplus (Accounting Research Bulletin No. 43, Chapter 1, Section B, paragraph 7(a)).

That ceiling is not simply what was paid in on the issue. It is the sum of all capital surplus arising from previous retirements and net gains on sales of treasury stock of the same issue, plus the prorata portion of capital surplus paid in, voluntary transfers of retained earnings, and capitalization of stock dividends on the same issue (Accounting Research Bulletin No. 43, Chapter 1, Section B, paragraph 7(a)).

A Reissue Never Reaches the Income Statement

This is the rule that separates a corporation’s own stock from everything else it buys and sells. Purchases and sales of its own stock relate to the capital of the corporation and do not give rise to corporate profits or losses, and the difference between purchase and resale prices is not reflected in earned surplus, either directly or through inclusion in the income account (Accounting Research Bulletin No. 43, Chapter 1, Section B, paragraphs 7 and 10).

Where the difference goes instead is specified. Gains on sales of treasury stock not previously accounted for as constructively retired are credited to capital surplus. Losses may be charged to capital surplus to the extent that previous net gains from sales or retirements of the same class of stock are already included there, and otherwise to retained earnings (Accounting Research Bulletin No. 43, Chapter 1, Section B, paragraph 7(b)).

Say a corporation with no earlier retirements and no earlier treasury stock gains on this class buys back a block at a stated price under the cost method, then reissues part of it above that cost and part of it below.

Repurchase
  Shares repurchased                    10,000
  Price paid per share                      $8
  Treasury stock, at cost              $80,000

Reissue A, above cost
  Shares reissued                        4,000
  Price received per share                 $11
  Cash received                        $44,000
  Treasury stock released, at cost     $32,000
  Credited to capital surplus          $12,000

Reissue B, below cost
  Shares reissued                        3,000
  Price received per share                  $6
  Cash received                        $18,000
  Treasury stock released, at cost     $24,000
  Charged to capital surplus            $6,000

Still held in treasury
  Shares                                 3,000
  Carrying amount, at cost             $24,000

The shortfall on Reissue B may be charged to capital surplus rather than to retained earnings because Reissue A had already put same class gains there, and that prior balance is the ceiling on how much can go there. Run the two in the opposite order and the shortfall lands in retained earnings, because no previous net gains from sales or retirements on that class would be sitting in capital surplus to absorb it. Neither reissue produces revenue, a gain, or a loss on the income statement.

Treasury Shares Versus Retired Shares

Holding and cancelling are different decisions, and only one of them keeps the shares issued.

Cancellation is sometimes compulsory. Shares that have been issued and then purchased, redeemed or otherwise reacquired must be cancelled if they are reacquired out of stated capital, if they are converted shares, or if the certificate of incorporation requires cancellation on reacquisition (N.Y. Bus. Corp. Law § 515(a)). Any reacquired shares not required to be cancelled may be either retained as treasury shares or cancelled by the board, at reacquisition or at any time after it (N.Y. Bus. Corp. Law § 515(b)).

The consequence is what the corporation can do next. Cancelled shares are restored to the status of authorized but unissued shares (N.Y. Bus. Corp. Law § 515(d)), so they leave the issued count and any later sale is a fresh issuance. Shares kept in treasury stay issued. Neither their retention nor their subsequent distribution to shareholders or disposition for a consideration changes the stated capital, and when treasury shares are disposed of for a consideration the statutory surplus is increased by the full amount of the consideration received (N.Y. Bus. Corp. Law § 515(c)). That surplus is a legal capital measure, the excess of net assets over stated capital (N.Y. Bus. Corp. Law § 102(a)(13)), not the capital surplus account the cost method credits.

When a Buyback Carries Federal Excise Tax

The charge attaches to the repurchase itself, whether the shares are then held in treasury or cancelled. A repurchase includes a redemption within the meaning of section 317(b) (26 U.S.C. § 4501(c)(1)), and stock counts as redeemed if the corporation acquires it from a shareholder in exchange for property, whether or not the stock so acquired is cancelled, retired, or held as treasury stock (26 U.S.C. § 317(b)).

Only a narrow class of corporations is in scope. A tax equal to 1 percent of the fair market value of any stock of the corporation repurchased during the taxable year is imposed on each covered corporation, and a covered corporation is any domestic corporation the stock of which is traded on an established securities market (26 U.S.C. § 4501(a) and § 4501(b)). A closely held company buying shares back from a departing owner is not a covered corporation, so that charge does not reach it.

Two provisions narrow it further for a corporation that is in scope. The tax does not apply where the total value of the stock repurchased during the taxable year does not exceed $1,000,000, and the amount otherwise taken into account is reduced by the fair market value of stock the corporation issued during the same taxable year, including stock issued to employees (26 U.S.C. § 4501(e)(3) and § 4501(c)(3)). The tax is figured on Form 7208, which is filed annually and attached to the Form 720 due for the first full quarter after the close of the tax year (IRS, Instructions for Form 7208).

Common Questions

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