4.16: Treasury Stock and Dividends

Treasury stock refers to shares a company has repurchased from its existing shareholders. The company holds these shares, but they are not considered when calculating earnings per share or dividends. When a company buys back its shares, it uses its available cash or bank balance, reducing its liquid assets.

The journal entry for acquiring treasury stock is recorded as: Dr. Treasury Stock / Cr. Cash.

The amount debited to the Treasury Stock account reflects the cost of purchasing the shares, not their par or market value. Treasury Stock is a contra-equity account, meaning it reduces total shareholders’ equity. On the balance sheet, it is shown as a negative figure under equity, usually on a separate line below retained earnings or additional paid-in capital.

Since treasury shares are not outstanding, they are excluded from earnings per share calculations and dividends. This treatment ensures transparency in reporting equity transactions involving the company’s shares.

Dividends, on the other hand, are distributions of a company's earnings to shareholders. When a dividend is declared and paid, it reduces retained earnings—the accumulated profits kept in the business—and the bank balance since cash is paid out.

While treasury stock does not impact net profit, it can indirectly improve key financial ratios like Earnings Per Share (EPS) by reducing the number of outstanding shares. However, dividends and treasury stock lessen the company's retained earnings and cash reserves. This means that, although they can be strategic financial tools, excessive use can weaken the company’s financial position by draining its cash and reducing retained earnings that could have been used for reinvestment.

Treasury stock refers to shares that a company has repurchased from existing shareholders.

For example, if Prim Corporation has one million one hundred thousand shares outstanding and decides to buy back ten thousand of its shares at ten dollars per share, it will spend one hundred thousand dollars on the repurchase.

These shares become treasury stock and are no longer counted as outstanding, reducing the total share count to one million.

Since Prim Corporation now owns these treasury shares, it is not liable to pay dividends on them or to grant voting rights.

Dividends are payments made by a company to its shareholders as a return on their investment in the business. Dividends affect the company’s retained earnings and bank balance.

For instance, if Prim Corporation declares a dividend of one dollar per share, it must pay out one million dollars. This decreases the retained earnings and the bank balance on the company’s financial statements.

Both treasury stock transactions and dividends impact shareholder value, influencing investor perception and overall company valuation.