4. Treasury Stock

Let's talk about treasury stock. When we talked about number of shares, we did something like this. We said the total amount that you can sell is the amount that has been authorized. Then you have some amount that has been issued. Then you have some smaller amount that is still outstanding. And way down here on this side, this is what we called treasury stock. Now, treasury stock is when the company buys back shares that are issued, and they may do that for a number of reasons. They may do it to avoid a hostile takeover. They may do it because they think the stock is undervalued, and so they think it's a good deal to buy their own stock, and so they'll use some of their excess cash to do that.

Regardless of the why, the what stays the same. The what is the company bought their own stock. Treasury stock is actually a contra shareholders' equity account. And here's what I mean. We looked at shareholders' equity and said shareholders' equity was retained earnings plus contributed capital. And we went through all the things that make up retained earnings and all the things that feed into contributed capital, right? Well, this isn't the entirety of the picture. Shareholders' equity does include those two components, but shareholders' equity also includes treasury stock. So you have to take out treasury stock to get the full shareholders' equity picture. So it's really retained earnings plus contributed capital minus treasury stock, and that is what gives you your total shareholders' equity.

So what kind of account is treasury stock? If it's a contra shareholders' equity, and we have the accounting equation like this, so we say shareholders' equity lives on the right side, so shareholders' equity is a credit account. It is increased by credits. Then treasury stock would be the opposite of that. Treasury stock would be increased by debits because it is a contra shareholders' equity. It is the opposite of shareholders' equity, so it is increased by debits. Now, unfortunately, I'm gonna kinda blow your mind because remember how we've talked about a stock having a par value, and then anything above that is called APIC? Unfortunately, this does not apply at all for treasury stock.

This applies for preferred stock and for common stock. For those two, you have a par value that's set. You have to cover that par value, and then you break into this APIC part of it. For treasury stock, it's actually easier. For treasury stock, you record it at cost.

Let's look at an example of that. If we purchased 300 shares of $1 par for $20, and we'll say it purchases 300 shares of our stock, just to be clear that this is a treasury stock problem. You'll usually see it like purchase 300 shares of its stock, of their own stock, repurchased 300 outstanding shares. You'll get the picture. The problem will then say, "What's the journal entry for this?" Now, once you recognize that it's a treasury stock problem, you should eliminate this par value. That's just there to throw you off because, like I said, with treasury stock, we don't have par value.

We don't deal with that at all. We strictly record it at cost. The par value will be there, and it'll be there just to throw you off really. If we purchase 300 shares at $20 a share, then we're looking at 6,000 of cash that we paid. So our cash is going to go down by 6,000, and since we've already decided that treasury stock is a debit account, we're in good shape. Treasury stock is going to go up by 6,000, and that's it. That's the entire journal entry right there. We decreased our cash, and we increased our treasury stock by putting 6,000 on the debit side.

Now, what happens when we sell treasury stock back? Now it's come full circle. It was outstanding. We bought it for treasury stock. Now we're selling it back out, and it'll be outstanding again. When we sell it, it kind of depends on how much we sell it for. For example, if we sell 100 of these shares that we've just bought, so if we sell 100 shares at $25, okay? So our selling price is greater than the price we bought it for. We bought it for 20. Now we're selling it out for 25. We first know that our cash is going to increase by 2,500.

The second thing is that we're going to decrease our treasury stock by the cost that we put it in at. So if we put it into treasury stock at $20, which we did, we paid $20 to buy it back, and that's how much we put it in at, we can't take out a single share at 25.

We have to take it back out at the price we put it in for. So when we take it out, we take it out at the cost. That's why here we've got 100 shares times the cost we put it in at for 2,000. Now, this difference is going to be additional paid-in capital treasury stock. Which is why in the first video, I told you that your contributed capital was gonna look something like this. Preferred stock number at some par, common stock number at some par value. Then you have APIC preferred, APIC common, and then finally you have this lone APIC treasury stock.

Preferred stock and common stock have a par value and an APIC. Treasury stock is down here by itself with just an APIC. It doesn't have par value because par value does not exist for treasury stock. It's just not a thing.

But should we sell our treasury stock for more than we bought it for, we just put that into this APIC treasury stock account. Now, here's where it gets really tricky. What if we sell 100 shares at $18?

Well, start with cash. Cash is gonna be 1,800. Now, this still applies. You can't put it in at 20 and take it out at 18. Just can't do that. So your treasury stock has to be 2,000 because it's 100 shares times the cost, so we have to take out the shares at the cost, not at what we sold them for. Now, this difference here could be one of two different things. The first thing that you wanna go for is you wanna go for the APIC treasury stock account. If there's any value in the APIC treasury stock account, go there first.

So take it out of APIC treasury stock first 'cause we put this 1,000 in when we sold it for greater than cost, and so we take this 200 out when we sell it for less than cost.

So this is kind of our slush fund. This is our treasury stock slush account. When you do a good job and you sell it for greater than cost, you put money in. When you do a bad job and you sell it for less than cost, you take money out. But what happens in the scenario where you sell it for less than cost and your APIC treasury stock account has nothing in it? Well, then you can't take it out of there.

You take it out of retained earnings. Your first option is always APIC treasury stock. You always wanna go to your slush fund and see if there's enough to cover your mistake here. If there's not, you have to go to retained earnings. And of course, you could have a scenario where if you really blew it, you got $1,000 cash and you had 5,000 come out of treasury stock, your APIC treasury stock account only has 2,000 in it, so unfortunately it gets even harder. You have to take out the 2,000 'cause you drain that account first always. Take out the 2,000, now you're at 3 versus 5, so then you have to take out 2,000 out of retained earnings to cover the difference when you made this huge mistake of selling your treasury stock way under cost of what you bought it for.

Let's do a quick recap because this can be a little confusing. When you're selling treasury stock, if you sell it for more than you bought it for, then the extra goes into APIC. If you sell it for less than you bought it for, you first wanna try to cover it with APIC. If you can't cover it with APIC, then you try to cover it with retained earnings. The first step on both of them is APIC. Of course, APIC treasury stock. You can't go looting the other accounts. You can't go looting common stock or preferred stock. If you sell treasury stock and you do a good job and you sell it for more than you bought it for, you put the extra into the APIC slush fund.

If you sell treasury stock and you do a bad job, you sell it for less than you bought it for, you have to go raid your slush fund, and if your slush fund empties out, then you have to go raid retained earnings directly.