Cost Method of Treasury Stock: Definition
The cost method is based on the assumption that the acquisition of treasury stock is essentially a temporary reduction in stockholders’ equity that will be reversed when the shares are reissued. It is widely used due to its simplicity.
Cost Method of Treasury Stock: Explanation
When shares are acquired, the Treasury Stock account is debited and the Cash account is credited. When the shares are reissued, Cash is debited for the proceeds and Treasury Stock is credited for the amount paid out originally.
In the event that the proceeds exceed the original cost, the Additional Paid-In Capital account should be credited. If the proceeds are less than the original cost, Additional Paid-In Capital should be debited.
For the following example entries, these facts are assumed:
The journal entries would be recorded as follows:
The Treasury Stock account should be viewed under the cost method as contra to all of the stockholders’ equity rather than any particular equity account.
Its balance represents the owners’ claims that have been satisfied by the distribution of corporate assets. The number of treasury shares should be disclosed in the description of the issue status of the shares, as shown in the following example:
In this case, the balance of the Treasury Stock account is deducted from total equity, including Other Paid-In Capital and Retained Earnings. If both common and preferred treasury shares are held, they should be disclosed separately.