 Hello and welcome to this session in which we will discuss the par value method when it comes to treasury stock. Now, we have to understand there are two methods to account for treasury stock. One is called the cost method and the other one is called the par value or the legal method. Now, the first thing we need to understand is what is treasury stock? Well, treasury stock is when the company buys back its own stock. For example, company A, they will buy back company A stock. Why am I making this distinguishment? Because company A could also buy company B, buy B stock. They can buy C stock. Well, when they do buy stocks other than their companies, it's called some sort of an investment. So that's the first thing we need to understand. There's a difference between buying back your own stock and buying back other company stocks. Now, why do companies buy back their stock? Well, I discussed this in the cost method. Could be many reasons. One is they want to show confidence in their own stock. Two, they want to reward the stockholders. Therefore, they buy back the stock. The stock price will go up. Three, they want to avoid maybe a takeover. That's why they buy back their own stock. It doesn't matter what the reason is. In this session, we need to understand how to account for treasury stock using the par value method or the legal method. Legal method or sometimes it's called the stated method. Let's go ahead and get started. Let's review real quick what we learned about in the cost method. Under the cost method, we account for any in quote gain, any in quote loss when we reissue the stock. So first we buy the stock, then down the road we might reissue the stock, that same treasury stock. When we reissue the stock, we might have a gain in quote or a loss in quote. At that point, when we reissue the treasury stock, when we reissue the treasury stock, we account for the gain or the loss. Under the par value method, when do we account for the gain or the loss when we re-purchase the treasury stock? So the point that we re-purchase the treasury stock, this is when we account for it. So under the par value method, that's what happens, but bear in mind, gain and loss, I keep them in quote. To remind you, those are not reported on the income statement. Yes, you have more money, sometimes you have less money by purchasing treasury stock. Although it appears, it looks, it smells, it acts like a gain or a loss, but it's not reported on the income statement. Same thing with the cost method. Simply put, transaction with the owners because you are buying back the stocks from the owners. You are selling the stock back to the owners. Don't report any transaction with the owners on the income statement. That's the key to remember, unless of course you're a company called Enron and you are cooking the books, then the gain or the loss would be reported on the income statement. And the absence of that, remember transaction with owners don't go on the income statement, whether it's a gain or whether it's a loss. So a few things to remember about treasury stock in general. No effect on the income statement. I keep saying this, but it's worth repeating. When you have a gain, it will not increase retained earnings. So hold on a second. So if I have a gain, what am I going to do? Well, it's going to increase some sort of paid in capital. And we'll see in an example, decreased retained earnings. Yes, sometimes you might incur a loss and the loss would reduce retained earnings. So retained earnings could be reduced by the loss, but it cannot be increased. So retained earnings cannot be increased with treasury stock. The best way to illustrate this is to take a look at an example to show you the effect of these transactions. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions as well as exercises. Go ahead, start your free trial today. No obligation, no credit card required. Adam Company issued 100,000 shares, a $1 power value for $5 per share. Now it's very important to know what was the original issuance of the shares. Well, $5. Let's start with this transaction. Let's first issue the share. Start with cash. It's easy. Cash, 100,000 shares times $5, that's half a million. Then we record common stock. Common stock is the number of shares times the power value. Make sure you know this. Number of shares. I'm going to write this here. It's very important times the power value. And this is called the power value method. The power value is important. Therefore, we credit common stock 100,000 and always additional paid in capital is a plug figure. Therefore, what's left is 400,000 additional paid in capital, common stock. So what we did is we issued the shares. That's all what we did. Now we are going to start to repurchase. We're going to repurchase 10,000 shares and we're going to pay $7. So look, we sold the shares at $5 initially. We issued them to the shareholders. Now we're buying back the shares at $7. Now from the company perspective, are we better off or less off? Well, think about it. We are less off. Now the shareholders are happy because if they bought them at $5, you are buying them back from them at $7, but we are not doing accounting for the shareholders. We are doing accounting for the company. So if you repurchase 10,000 shares at $7, start with cash. The company will have to issue a check for $70,000, 10,000 shares times $7. The next thing you do is you debit an account called treasury stock. Now since we are using the par value method for treasury stock, since we are using this method, it's called the par value, we're going to debit treasury stock and we're going to credit treasury stock at par, whether we debit or credit. So we're going to debit treasury stock at par. What's the par? Well, it's very important to notice. Don't lose track. The par is a dollar. I kept it a dollar easy. The par could be any number. So we're going to debit treasury stock at 10,000. Now what is treasury stock? Treasury stock is a contra equity account. So it's an equity, but it's the opposite of equity. That's why it takes a debit balance when you are increasing it and it reduces your equity. It's a contra equity. Well, what else do we need to know next? So we started with cash. That's easy. We debit treasury stock at par. That's easy. What's next? Well, next determine whether you have a gain or a loss. Well, think about it. From the company's perspective, they are $2 worse off for each share and they purchased back 10,000 shares. Well, they have a loss. Again, a loss. I'm going to put a loss in quote because it's not a loss that goes on the income statement of $20,000. How do you record this loss? Here's how you record this loss. First thing you do is you would look to see if you have an account called paid in capital treasury stock. If you have any amount and paid in capital treasury stock, the loss will go against this amount. But in this example, I showed you, I showed you no paid in capital treasury stock. So you assume that paid in capital treasury stock is zero. Well, if the paid in capital treasury stock is zero, what do you have to do? Then you have to take the loss and debit retained earnings for $20,000. So what is paid in capital treasury stock? So how does this account comes into life? This account where we book the in quote, the gain in case we have a gain. So in case we had a gain in the past and now we have a loss, the loss can be used to offset the gain. But in this example, I'm telling you, there's no gain. But if there is a gain, if they're giving you statements of equity and there's paid in capital, again, treasury stock, and there's a number there and you incur the loss, first the loss will go against that paid in capital treasury stock to bring the paid in capital treasury stock down to zero. Once you no longer have paid in capital treasury stock, anything remaining from the loss would go to retained earnings. So I'm assuming here I already have a zero in paid in capital. That's good. Now the transaction does not balance. The last thing you book is additional paid in capital common stock. Basically, you book this account, you reduce additional paid in capital treasury stock, and this is a plug. Now, I consider this a plug. Some CPA review course, they would say, no, this is not really a plug. This is, yeah, there's another way to compute this. It is 10,000 shares times the additional paid in capital. What is the additional paid in capital? Look, I'm sorry, the additional paid in capital, the additional paid in capital. What's the additional paid in capital? Well, remember, we issued each share for five. One dollar was par. The additional paid in capital was four. So it's 10,000 times four dollars because this is the additional paid in capital is 40,000. Well, I would like to look at it as a plug. If you want to look at it as this is your reverse the additional paid in capital, it's up to you. I believe it's easier to always remember that additional paid in capital common stock is a plug. Let's look at another scenario. Adam repurchased 20,000 shares now at $3. Well, start with cash. If we repurchase 20,000 shares at $3, we have to pay 60,000. Credit cash, 60,000. That's fine. The next thing, again, we are buying treasury stock. Debit treasury stock at par, which is 20,000 shares times a dollar, 20,000. Now determine whether you have a gain or a loss because under the par value, you have to determine the gain or the loss when you repurchase the shares. You issued the shares at five. Now you're buying them at three. Do you have a gain or do you have a loss? Well, you have a $2. You are $2 worse off and you bought 20,000 shares. So you have a gain of $40,000. Now how do you book this gain? Easy. You always book the gain paid in capital treasury stock. And this is how paid in capital treasury stock now exists. Before we did not have any balance. Now we have $40,000 balance. Okay. So we don't credit retained earnings. So we don't go back and say, well, we reduce retained earnings. We're going to go back and reverse it. Transaction with owners don't increase retained earnings paid in capital treasury stock. What's left? The transaction does not balance. It's always against additional paid in capital common stock. Additional paid in capital. Notice this is common stock is 80,000, which is the plug to make the entry balance. And if you want to take a look at it as it's at 20,000 and I'm reversing $4 additional paid in capital. That's gives you also 80,000. It does not matter. So notice here what I did. I issued the stock at five. I showed you when it's issued at a loss for the company. Again, from the company, it's a loss when it's issued at seven from the shareholder. It's a gain, but our concern is not the shareholder. And when we issue it at a gain, we book the in quote gain in an additional paid in capital. Now we're going to go back and start to the issue treasury stock. Now Adam reissued 5,000 shares at $8 and those 5,000 shares are from the treasury stock. Because remember, we bought 10,000. We have 30,000. We're going to issue 5,000. That's fine. Debit cash for 40,000. That's easy. Start with cash. Now, since you are issuing the treasury stock, you have to get rid of the treasury stock. You always debit and credit treasury stock for the par value. This is the par value method. Par value method for treasury stock. Therefore, I'm going to credit treasury stock 5,000 shares times $1. That's the par value. And guess what? Anything left is paid in capital. Common stock 45,000. So notice here, I issued them at 8. Let's issue the shares at $2. Issue 10,000 treasury stock at $2. Again, at $2, I'm going to get 10,000 shares times $2. It's going to give me 20,000. I'm going to remove the treasury stock at par 10,000 shares times 1. And anything left, it's additional paid in capital, $10,000. What should you do now? You should go to far hat lectures and look at additional MCQs, true, false, additional resources, exercises, the cost method that's going to help you to account for treasury stock. Remember, treasury stock will have the cost method, will have the par value method. Now, in the real world, also in college courses, they always teach you the cost method because that's the one that most commonly used. But on the CPA exam, they hold you accountable for the cost method as well as the par value method for treasury stock. Study it, learn it. I'm always here for you. Good luck. Study hard and, of course, stay safe.