Why Is Treasury Stock Subtracted From a Stockholders' Equity?

Publicly traded companies may engage in different types of transactions in their stock after their initial public offering. For example, a company may issue new shares or repurchase existing shares. When shares are repurchased, they are referred to as Treasury shares and are accounted for by reducing the company's stockholders' equity.

Overview of Treasury Stock

Treasury stock refers to the shares repurchased by a company. Management teams elect to repurchase shares for a number of reasons. One of the main justifications is the perception by management that its shares are undervalued and that a share repurchase will support the stock price and generate a strong return. Another popular motivation is to acquire shares for use as employee compensation in stock option programs. Companies may also purchase shares in "going private" transactions involving a delisting from a stock market exchange.

Overview of Stockholders' Equity

A corporation's balance sheet is made up of assets, liabilities and stockholders' equity. Assets are debit balance accounts, while liabilities and stockholders' equity are credit balance accounts. Stockholders' equity represents the difference, or residual, between assets and liabilities. It consists of common stock, preferred stock, additional paid-in capital, retained earnings and Treasury stock. In other words, the stockholders' equity account reflects the capitalization of the company.

Accounting for the Purchase of Treasury Stock

When a company repurchases shares, the stockholders' equity account is debited to reflect the decrease in capitalization and the cash account is credited to reflect the expenditure of cash. For example, if a company repurchased $100,000 of its shares, the Treasury stock account would be debited $100,000 and the cash account would be credited $100,000.

Accounting for the Sale of Treasury Stock

When a company releases Treasury shares, the stockholders' equity account is credited to reflect the increase in capitalization and the cash account is debited to reflect the receipt of cash. For example, if a company released $100,000 of its shares, the Treasury stock account would be credited $100,000 and the cash account would be debited $100,000.