Stock buybacks have become commonplace in corporate America, and thousands of companies routinely repurchase shares that they've previous issued. When they do so, it's important to account properly for the transaction and to understand the impact it can have on other financial metrics.
Why treasury stock is special
When a company buys back stock it has previously issued, it becomes what's known as treasury stock. The purchase doesn't reduce the number of shares the company has issued, but it does reduce the outstanding share count.
Treasury stock has some differences from regular stock. Companies don't make dividend payments on treasury stock, since it would essentially involve paying itself. Treasury stock doesn't have voting rights and is ignored for purposes of establishing required majority or supermajority votes on corporate issues.
Perhaps most importantly for investors, Treasury stock isn't included in the share count in determining key figures like earnings per share. That's why buybacks typically boost earnings per share, because the number of shares falls while leaving earnings constant. Similarly, a company can raise capital by reissuing treasury stock onto the open market, but earnings per share can fall, and the company will have new dividend obligations for the shares.
Accounting for treasury stock reissuances
Reissuing treasury stock also has accounting implications. If the price at which the stock is reissued differs from what the company paid for the treasury stock, then it will have to recognize a gain or loss on the reissuance.
Specifically, when a company reissues treasury stock, three things will typically happen on the balance sheet. First, the amount in the company's treasury stock account will decline by an amount equal to the number of shares reissued multiplied by the price the company paid when it originally obtained the treasury stock. Second, the cash account will rise by the cash proceeds from the sale of treasury stock. Finally, any resulting profit increases the line item for paid-in capital from treasury stock, while a loss reduces that line item.
For investors, the net result is that you can see how good a job a company does with buying back and reissuing treasury stock by looking at its balance sheet. If paid-in capital from treasury stock is a positive figure, then the company has timed its buybacks and offerings well. If it's not, then the company hasn't had the favorable timing that investors would have preferred.
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