RUNNING HEAD: PAR VALUE OR COST METHOD WHEN ACCOUNTING FOR TREASURY STOCK
DATE OF SUBMISSION:
TO: Board of Directors
SUBJECT: Strategic Accounting: Par Value or Cost Method
In order to achieve balance between debt capital and equity capital as put in (Young & Yang, 2011) a company may choose to engage in share buy back programs. A share buy back is a situation where a publicly owned company purchases its own shares from the stock market. This has been a strategy embraced by many companies in the recent past but has been slowed down by economic down turns that have affected publicly owned companies globally as argued in (Young & Yang, 2011).
A company engages in stock repurchase for various reasons ranging from need to balance debt capital with equity capital and for employee compensation programs in future.
Stock that a company buys back from the stock market is known as treasury stock because a company cannot be its own share holder. This stock is not also considered as the company’s assets. Treasury stock aids the management of the company in managing its balance sheet.
When accounting for treasury stock a company may chose between two methods that is, the cost method or the par value method as outlined in the Generally Accepted Accounting Principles (GAAP).
PAR VALUE METHOD
This method of accounting for treasury stock does not show treasury stock on its balance sheet. The treasury stock is deducted from the paid in capital and treated as retired stock. If the boards of directors may decide to retire the shares for good or resale the treasury stock back to the market.
To determine whether a company is buying back its own stock you have to examine the cash flow statement because they have to account for the cash outflow and the statement of shareholder’s equity that will reflect a decrease in the value and number of ordinary shares.
If the company purchases the shares at a value above the par value the additional amount above the par value is deducted from the retained earnings.
THE COST METHOD
The cost method is the most prevalent method among companies. The cost method accounts for treasury stock in a contra account known as the treasury stock account after the shareholder’s equity section. When a company buys treasury stock it debits the treasury stock account and credits cash. If the company sells the treasury stock back to the stock market the entry in its journal accounts will be reflected as a credit in the treasury stock account and a debit to cash.
The stock is reflected at the cost that the company incurred in the repurchase at the stock market. The treasury stock is also reflected in the balance sheet at the equity section as a deduction.
IMPACT OF TREASURY STOCK REPURCHASE
Stock buy backs also help increase a company’s earning per share. By buying back share from the stock market they reduce the number of shares by shareholders which in turn increases the earnings pre share because net income or shareholders earning are not affected according to (Young & Yang, 2011).
Share repurchases triggers trading in the stock market by individual shareholders. The increases in earnings per share of the company attract investors in the market to demand for its shares as put in (Young & Yang, 2011).