 Hello and welcome to this session in which we would look at an example that deals with treasury stock. Now what is treasury stock? Well treasury stock is when the company buys back its own shares. So simply put, company A buys stock of company A. So when you buy back your own stock, it's the opposite of issuing the shares. When you issue the shares, you sell your common stock to the public. Then with the treasury stock, you go out there, take your cash and buy back the stock. Now why would you do that? We'll look at an example. So let's take a look at this example to illustrate the concept of treasury stock. Adam Time's Inc. has 50,000 shares outstanding, $10 par value common stock, which were issued for $40 per share. Simply put at some time in the past, Adam Time's Inc. issued 50,000 shares and received $40 per share. Simply put, if you want to look at the cash, the cash for the Time's company was $2 million. We credit common stock for the number of shares, $50,000 times the par value, which is half a million and the remainder was paid in capital, common stock for $1.5 million. So this was the original entry. The company decided to buy back its own shares to send a positive signal to the market. The reason I called it Adam Time's is to illustrate the concept that at some point the New York Times, what they did, that's what they did in 2001, between 2001 and 2003. Between 2001 and 2003, the New York Times were so confident about their company. So what they did, they bought other newspapers and they bought back their own shares. So they had a lot of cash on hand. So what did they do? Well, they bought other newspaper, other physical newspaper across the country and they bought back their own shares. Why? Because they thought the future looks bright for the New York Times and at that time the New York Times did not really care about their online presence. So rather than taking this cash and invest this cash in their online presence, they wasted this cash on buying back their own shares and making lousy investments by buying physical newspaper which the business of physical newspaper is dying unless you are the Wall Street Journal. So to make the long story short, two years later, the New York Times had to file for a bankruptcy because their stock price fell below the price of an actual newspaper. At some point, you could buy the New York Times stock for less than the newspaper itself. The point I'm trying to make is not every time a company buys back its own stock, it's a good move. For example, the New York Times invested in their own company but they bellied up and they had to file for a bankruptcy and they came out of it but the point is it's not always a good choice. Now let's take a look at the journal entry. 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. We purchased 5,000 shares at $50 so Adam went to the market and bought back basically 10% of their shares. Well, we have to pay $250,000, we credit cash and we debit an account called Treasury Stock, Treasury Stock for $250,000. Now I highlighted 50 in yellow to illustrate this is the cost of Treasury Stock. This is how much we purchased them at $50. Now what type of account is Treasury Stock? Treasury Stock is a Contra Equity. So what happened in this entry, assets went down because we paid cash and equity went down because we added a Contra Equity. So both asset and equity went down. So we debit the Treasury Stock, credit the cash. Now we resold 1,000 of our Treasury Stock at $55,000. So remember we purchased 5,000, now we're going to go out there and resell them. And we resell 20%, which is 1,000 shares of our own Treasury Stock. Well we sold them technically above what we paid. Well when you sell something above its cost, technically you have a gain. We cannot call this a gain, simply put we made $5 in, quote, profit. Now if we take this $5 multiplied by 1,000, technically we have $5,000 in profit. Let's see how we journalize the entry. Let's start with the easy part. We received cash of $55,000, 1,000 times $55,000. So you can always start with cash. The next thing you have to do is to remove the Treasury Stock. You would remove Treasury Stock at cost because we are using the cost method. There's the cost method and there's the power value method. We're not using the power value, we're using the cost method for accounting for Treasury Stock. So we accounted for the cash, we removed the Treasury Stock at cost, the remainder is $5,000. Again, technically it's a profit. It's an improvement in our economic situation. We are $5,000 better off because we sold them at $55,000. What do we have to do? We have to credit an account called Paid in Capital Treasury Stock, which is $5,000. Paid in Capital Treasury Stock is an equity account. And this is what we did. We increased our equity. We assumed that we had no prior balance in Treasury Stock. We assumed this balance was zero. Now we have a $5,000. Let's keep on going. We resold $1,000 at $42,000. Now again, you cannot book this as a gain. Be careful. This is not a gain. You cannot book a gain from your own stock unless you're a company called Enron, which no longer exists because they did stuff like that. So this $5,000 cannot go on your income statement. Now you resold $1,000 shares at $42,000. So again, you resold some of the shares. You remember you purchased $5,000. You resold $1,000. Now you resold another $1,000 at $42,000. Let's start with the entry. Start with cash. Again, cash is easy, $1,000 times $42,000. We received $42,000 in cash. We removed Treasury Stock at cost, $1,000 times $50,000 is $50,000. Now notice here, in this transaction, we are at a loss of $8,000 because we bought them at $50,000, sold them at $42,000. What do we have to do now? Well, here's what we have to do. When we have a loss, first we have to see, first we go in order. We have to see if we have any paid-in-capital Treasury stock, if there's any paid-in-capital Treasury stock can absorb some of the losses we park it there. So of the 8,000, we can see that paid-in-capital Treasury stock can absorb 5, therefore paid-in-capital Treasury stock go down to zero. You cannot have a debit balance and paid-in-capital. So we have the remaining of 3,000. So let's book first the 5,000. So we debit it paid-in-capital 5,000, paid-in-capital Treasury stock 5,000 is done. Now we have a remainder of $3,000 of losses. What do we do when we don't have paid-in-capital Treasury stock? Once again, we don't hit the income statement. We reduce retained earnings. So what we do is we reduce retained earnings directly on the balance sheet, skipping income statement. So yes, we are worse off, but we don't show it as a loss on the income statement. I believe if we show it a loss, it's even more conservative. But again, we don't want to mislead anything for the income statement. We just hit retained earnings and retained earnings will go down. And this is one of the few things that you need to be aware of retained earnings. Remember, net income increases retained earnings, net loss reduces retained earnings, dividend reduced retained earnings. And notice here, Treasury stock losses could reduce retained earnings as well. But the only thing that should increase retained earnings is net income or errors that would result in an increase in net income. So very few things, well, not few, only one thing should increase retained earnings and that's profit. And that's basically an example, an illustration of Treasury stock. What should you do now? Go to farhatlectures.com, work MCQs, true, false, additional exercises. Your CPA exam is worth it. Your accounting education is important. Invest in yourself. Invest in your career. Yes, you're going to be spending time studying. It will pay later. Good luck, study hard and stay safe.