 Hello and welcome to this session. This is Professor Farhad and this session we would look at accounting for treasury stock. This topic is covered in introductory financial accounting course, the CPA exam as well as intermediate accounting. As always I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1600 plus accounting or I think finance and tax lectures. This is a list of all my courses. If you like my lectures, please like them, share them, put them in playlists, subscribe. If they benefit you, it means they might benefit other people, so share the wealth. Connect with me on Instagram. On my website you'll have access to additional resources such as PowerPoint slides through false multiple choice exercises. So if you are looking to pass the CPA exam or supplement your accounting education, I strongly suggest you check out my website for those additional resources. So treasury stock, what is the basic idea behind treasury stock? What we learned earlier that the company, if they need money, so if we have a company here and if they need money, they will sell stocks to individuals and those individuals, they will give money back to the company. So that's just how we issue stocks. Now at some point in time the company is going to be making some profit and what they do, they can buy back the stock. So they can give back the money to the individual and the individual will sell the stock back to the company. When this happened, this process is called treasury stock. So treasury stock represents shares of a company's own stock that has been acquired. A corporation might acquire stocks for various reasons. For example, sometime what they would need to do, they will need to buy another company. A case in point is Microsoft. Microsoft bought linked in. When they bought linked in, they used stocks. So they took Microsoft stocks and they gave it to linked in shareholders. That's what they did. They purchased the company by stocks. So first you have to have the stocks in order to buy it. The second reason is to avoid hostile takeover. What is hostile takeover? It's when management fears that someone is trying to buy them out. So what they do, they will try to buy their own stock from the hands of the hostile takeover before those stocks fall into the wrong hands and they will be bought and most likely they fear being fired from the company. Three, reissue employees as compensation. So sometime what companies do, they compensate, they reward their employee by paying them with stocks. So in order to give someone stocks, you have to have it. If you don't have it, you have to buy it, then give it to the employee. Also maintain a strong market. This is the point where Apple computers does all the time. When Apple computers feel that the market is not rewarding their stock. In other words, no one is buying Apple stock because no one believes the company is going to do well. So what they do, Apple itself, because if they have cash, they will start to buy the stock to maintain a strong market in their stock, to tell the users, to tell the investors that we have confidence in our own stock. Now not all companies buy treasury stock, but a lot of companies more than 50% buy their own stocks, buy back their own stocks and 38% they have no treasury stock. So the best way we have to deal with this as accountant is to know how to journalize those entries. So the only way to illustrate this is to work a couple examples. On May 1st, Cyber Company purchased 1,000 of its own shares in an open market for $11.50. Now $11.50 is the cost. So they paid $11.50 per share. Now what entry do we make? Well, we paid 1,000 for 1,000 shares, $11.50. Therefore, we paid $11,500 cash goes down and treasury stock common goes up. So notice this is a contra equity account. So treasury stock is a contra equity. It went up. Now remember, we have to keep track of our cost. That's important and you will see why later on when we resell the stocks. So treasury stock is shown as a reduction in total stockholders equity. It's a contra equity. It's a negative equity and that's why it has a debit balance because equity has credit balance. If it's negative, it's the opposite. It will have a credit balance. So this happens on May 1st. Let's assume on May 21st, 20 days later, we sold 100 of those shares at exactly $11.50. What does it mean at $11.50? It means we sold them exactly for the price that we purchased them. Therefore, we debit cash $1,150. We credit treasury stock $1,150. So remember we had $1,000 shares purchased. We resold 100. We still have $900 in treasury. Now let's look at another example. Let's assume on June 3rd, couple weeks later, we sold an additional $400 shares at $12. What does $12 mean? It means we sold them more than $11.50 above cost. What is cost? Cost is $11.50. So first, we record the cash. The cash is $400 shares times $12, which will give us $4,800. We will remove treasury stock at cost. What does it mean at cost? It means we're going to be removing $400 shares at $11.50, which equal to $4,600. The remaining is $200. Technically, this $200, technically, I'm going to put it in quote, it's again, you cannot book again from selling your own stock. You can do so. So what happened is it's considered paid in capital. It's as if the owner contributed money to you, but it's paid in capital treasury stock. Now what you need to do for this account, you need to create this account and keep it separately, paid in capital, treasury stock and park in there $200. And you will see why that's important. So simply put in this example, we made a profit of $200. We purchased the shares at $11.50 cost us $4,600. We sold them at $4,800. We have a gain, which we cannot call again. Technically, it's a gain, but we cannot call again. We call it paid in capital treasury stock. Now let's assume we sold. Remember, we had $900. We had $1,000 shares initially. We sold $100. We were down to $900. Now we're going to sell. I'm sorry. Then we sold $400 here. We were down. We will sold $400 in this transaction. We are down to $500. Now we're going to sell the remaining $500. And we're going to sell the remaining $500 at $10. What does that mean? It means we sold them below $11.50 because our cost is $11.50. Remember, remember when I said it's very important to keep track of your original cost $11.50. So here we go. We're going to receive cash, $500 shares times $10, which is $5,000. We are going to remove treasury stock at cost. The cost is $500 times $11.50. Now we have a total loss of $7.50. Why? Because we sold something for $5,000. Well, it has a cost. This is the cost of $57.50. So we have $7.50 of in quote losses. What do we do with those losses? Here's what we do with those losses. We have $7.50 of losses. The first thing we look for is to see if we have any paid in capital treasury stock. And indeed, we do have $200. Therefore, of that $7.50, we're going to allocate $200 to paid in capital treasury stock and bring paid in capital treasury stock down to zero. That's done. Well, if we gave paid in capital treasury stock allocated $200, we still have $5.50. Once paid in capital treasury stock is gone, then the remaining would reduce retained earnings. Now, this is important because generally speaking, we don't touch retained earnings, but we will in that situation. So in this situation, we are going to reduce retained earnings. Now, so the remainder will go into retained earnings. Regardless, all the loss, no income statement. So we did not hit the income statement with these losses, although we had losses, but it did not reach the income statement. Let's take a look at another example to see how this all worked. We have this company, they have common stock, $10 power value, 500 shares authorized, 200 shares issued an outstanding, paid in capital, $1,000. We have retained earning of $5,000, total of $8,000 of equity. First, we purchase 30 shares on July 1st at $20. So July 1st, we purchase 30 shares, which cost us $600. And this is the cost of the treasury stock. So our cost is $20. So we have to keep track of our cost because when we resell those shares, we have to determine whether we sold them above or below the cost. So that's it. We finished July 1st. September 1st, we sold 20 shares at $26. We sold them above the cost. We debit cash for 20 shares times $26. We credit treasury stock at cost, which is $20, $420. And the remaining is paid in capital treasury stock or what I called in quote, gain, which I cannot consider the gain because gains go on the income statement. Then I sold the remaining 10 shares because I purchased 30 initially. I sold 20, then I sold 10 at $7. I sold them below my cost. My cost is 20. I sold them way below my cost. First, I book my cash. My cash is $70. I remove my treasury stock at cost. The cost is $200. Well, the difference between what I received and what I paid is $130. Now, what's going to happen to this $130? $120 would remove this paid in capital and the $10 remaining would reduce retained earnings. So it's very important to remember that if you don't have paid in capital, once it go down to zero, specifically paid in capital treasury stock, the remaining would reduce retained earnings. And it's very important to know this because in the next session, I'm going to be looking at the statement of retained earnings and stockholders equity. If you like this recording, please like it, share it, put it in playlist, especially these days with the coronavirus out there. It might benefit other people. And as always, I would like to remind you to check out my website if you're looking for additional resources to pass your CPA exam and get over with your studies. You want to put this exam behind you. You want to get on with your life, focus on your career. Stay safe.