 Hello and welcome to the session in which we will discuss treasury stock. What is the big idea of treasury stock? Well, treasury stock is when the company buys back its own stock. Now we have to be careful. It's when company A buys back company A stock. For example, company A can buy company B stocks. Well, that's an investment. That's not what we are discussing here. It's when the same company, it's when Walmart buys back Walmart stocks. When Apple computers buys back its Apple computers and Apple does it all the time. But that's the treasury stock. So once they buy back their own stock, we call that treasury stock. Now the question becomes, why do companies buy their own stock? Well, there are many reasons. We're going to go over some reasons, but that's that's not the accounting part of it. But we need to understand why because once you understand why the concept, it's easier to understand the accounting part. One reason could be increase earnings per share. What is earnings per share? Earnings per share is basically net income. The earnings of the company divide in it by, so for example, net income that belongs to the common stockholders divide in it by the shares. So if the company made $100,000 in net income and they have, let's assume, for the sake of simplicity, 100,000 shares, we would say that each shareholder earns a dollar on average. Now, if we reduce the number of shares, if we buy back shares and now they're no longer outstanding, let's assume for the sake of illustration, we buy back half of our shares, which is that's very expensive. But the point to make is if we bring down the shares, earnings per share becomes $2. So it looks like your earnings per share is better. Increase return on equity, same exact concept. What is return on equity? It's net income divided by equity. Equity is the stocks. So if you reduce the amount of the stock's outstanding, you would improve return on equity, the same concept as earnings per share. Also, some companies, what they do is they buy back their own shares to avoid takeover. What does that mean? To take over a company, you have to buy enough shares that you have control. So once management feels there is some hostile activities, hostile means someone is trying to buy their companies and maybe hostile means they want to buy the company, maybe they want to kick the management out. They don't like what the management doing. The management might try to buy those shares from the hands of the hostile shareholders. That could be another reason. Another reason could be to grant stocks to employees. So companies, sometimes they compensate their employees by giving them stocks and we'll see this in the next chapter when we talk about stock options and stock stock rights. So to have the stocks, you have to buy them. Therefore, you buy back your own stock. You want to reward the current shareholder in a tax efficient way. What does that mean? It means you want the stock price to go up, but you don't want them to pay taxes. How does that work? Well, if you buy the stock, you bid the price up. When the price goes up, the shareholders will have an unrealized gain and you don't pay taxes on unrealized gain. Another reason is you make market in the stock. What does that mean? It means the stock, the stock, maybe there's not enough buyer and sellers. So you want to buy and sell your own stock so you will make a market. So you'll be on the other side. If somebody wants to sell, you buy it. If somebody wants to buy it, you sell. So you make a market. Now, let's start with an example to illustrate this concept because the only way to illustrate it is to work with numbers. And let's assume Farhat Lectures issues one million shares at $1 par value common stock at a price of $15. In addition, it has retained earning of half a million. So this is what the equity section of Farhat Lectures looks like. Common stock of a million, they issued 100 shares of $1 par. They received 15 million in total. Therefore, the remaining is additional paid in capital and retained earnings is half a million over the years, over the years. So total stockholders' equity is 15.5 million for this Farhat Lectures company. Now, what's going to happen is this. On March 1st, Farhat Lectures, it's going to buy 100,000 of its shares. So notice here we have 100 million. We're going to buy back 100,000. What entry do we make? And we're going to pay per share $10 per share. Remember, we sold them at 15 when we sold them originally. Now we're going to buy them back at $10. We're going to debit an account called Treasury Stock for the amount of a million, and that's based on cost. And remember, the cost is important because we're going to be using the cost method $10. And obviously we paid $1 million in cash to buy those stocks. So this is what the stockholders' equity looks like before the purchase. This is before we made the purchase. And this is after. So after the purchase, we have 1 million shares issued, but only 900,000 outstanding. Additional paid-in capital, still 14 million. So we still have total paid-in capital, 15 million. Retained earning is half a million. Then what we do is we reduce. So Treasury Stock is a Contra equity account. So notice it's less 1 million of Treasury Stock, which is 100,000 shares. Now, total shareholders' equity is 14.5 million. It used to be 15.5. Now it's 14.5. So equity went down by a million and cash went down by a million. And this is why the entry-state balance. Now, let's start to sell those Treasury Stock because, okay, we bought them. That's fine. We bought each share at $10 and make a note of this because that's important. The next thing we're going to do is we're going to resell those shares. So when we resell those shares, what do we do? What entry do we make? Well, before we take a look at the entries, when we resell the shares, I would like to remind you whether you are an accounting student or a CPA candidate to take a look at my website, farhandlectures.com. My motto is saving CPA candidates and accounting students one at a time. I provide you additional resources that's going to help you understand your concept, your material better. Your risk is one month of subscription. You can give it a try. I don't replace your CPA review course. I am a supplemental tool. I can help you understand your CPA review course better, which will help you do better on the exam. This is a list of my accounting courses that I have. I have lectures, multiple choice, true, false. Practically all accounting courses, my CPA supplemental resources are aligned with your Becker, Roger, Wiley and Gleam. So it's very easy to go back and forth between my material and your CPA review course and for CPA students. And actually for everyone, I give you access to 1500 previously released AI CPA questions with detailed solution. That is in addition to thousands of practice questions. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation like this recording. Share it with other connect with me on Instagram, Facebook, Twitter and Reddit. So what we're going to do now is we're going to try to sell some of those treasury stock. We have one million in treasury stock. We're going to try to sell them back to the public. So let's take a look at the journal entries. The first one is March 20th, which is two weeks later. We sold 10,000 shares at $14. That's great. If we sold 10,000 shares at $14, we received 140,000 in cash. Well, we remove treasury stock at cost. So make a note of this. We remove treasury stock at cost. The cost is $10. We sold 10,000 shares. We removed it at cost. Now we bought it at 10. We sold it at 14. Well, guess what? We have in quote again. And I say in quote because you cannot record the difference as a gain. So we have a credit of $40,000, basically a gain. How do we book this gain? Well, it's not a gain. It's basically a contribution from the people who bought it. So it's basically an equity. So paid in capital from treasury stock. So notice what's happening. I'm keeping track of my treasury stock. I had just reduced it by $100,000. Now I have $900,000. And this $40,000, I'm going to put this in quote and gain. Again, that we experienced, we booked it to paid in capital treasury stock. So keep track of two accounts. Keep track of your treasury stock. This account here and keep track of your paid in capital treasury stock. That's important. So this is what we did. And it's not a bad deal. We bought them at 10. We sold them at 14. We raised an additional $40,000. We cannot call it a gain. It's basically contribution from the shareholders. April 5th, we sold an additional 10,000 shares at $9. The stock price started to drop, which we sold the whole thing earlier. Okay. Now when we sold them for $9, we're going to be receiving $90,000 in cash. We're going to remove treasury stock at $100,000. So notice we reduced treasury stock again, $100,000 because we remove it at cost. Now we have technically a loss based on this. How to book the loss? Listen to me carefully. This is important. This is the trick here. If you have any paid in capital treasury stock that can absorb the loss, you will book it there. Do we have? Yes, we do. We have losses of 10,000 and we have treasury stock paid in capital of 40. So what's going to happen is we're going to let the paid in capital treasury stock absorb the loss. Therefore, what we do is we reduce paid in capital treasury stock by 10,000. And now we have remaining 30,000 in treasury stock. Let's take a look at May 1st. Again, a month later, a little bit less than a month, we sold an additional 10,000 shares now at 6, the stock keep dropping. We received $60,000 in cash. We have to remove treasury stock at $100,000. So we removed it, we reduced more treasury stock. And what happened is now we have to book $40,000 of losses. How are we going to book the losses? Well, we already know we already have $30,000 remaining in paid in capital treasury stock. Well, if that's the case, let treasury stock absorb, paid in capital treasury stock absorb 30,000. So what's going to happen? We debit treasury stock an additional 30,000, thus bringing paid in capital treasury stock to zero. We still have 10,000 to book. Can we book a loss? We cannot book a loss. We cannot let this transaction hit the income statement, earnings. So what we do is we reduce retained earnings on the balance sheet by 10,000. Therefore, we book it in retained earnings. To learn more about this topic, I would suggest you go to my multiple choice on farhatlectures.com and start to work multiple choice. Look at the additional resources to learn this important topic. At the end of this recording, I'm going to invite you again to visit my website, whether you are a student or a CPA candidate. Don't shortchange yourself. Your accounting education, your CPA certificate is a lifetime investment. Get the education, get certified, move on with your life. It's worth it. My investment, your investment in my courses will not, it's not going to break you. You give it a try. It helps you, you keep it. It's going to pay you dividend four years. Good luck, study hard and of course, stay safe.