This is alot but very informative
Reacquiring shares of stock
Companies sometimes acquire their own shares of stock. Such shares may be used for employee incentive programs, future mergers with other companies, or for other reasons. In general, when a company acquires its own stock, its resources (assets) decrease and its sources of resources (stockholders' equity) decrease. The specific accounts affected depend upon the type of stock purchased and what management intends to do with the shares.
Reacquiring common stock When a company acquires its own common stock, it may either retire the shares or hold them for future use. To understand the effects of both options, it may be helpful to review three aspects of common stock. First, the total number of shares a company may issue, based on its articles of incorporation, is called its authorized shares. Second, the total number of shares sold to owners is called issued shares. Third, the total number of shares in the hands of owners is called outstanding shares. As you will see in the following discussion of treasury stock, it is possible for a company's issued shares to differ from its outstanding shares. At this point, however, assuming treasury stock does not exist, a company's issued shares will equal its outstanding shares and both will be less than its authorized shares.
For example, assume a company's articles of incorporation provide for the possibility of 40,000 common shares to be sold. In such a case, the company's authorized common shares are 40,000. If 10,000 common shares are sold to owners, the company's issued shares become 10,000. If all 10,000 issued shares remain in the hands of owners, the company's outstanding shares are also 10,000. As a result, the company's authorized shares (40,000) are more than its issued shares (10,000) and outstanding shares (10,000). Note also that the number of issued shares (10,000) equals the number of outstanding shares (10,000).
Retiring common stock When a company retires some of its common stock, it purchases them from owners and reduces the number of shares issued and the number of shares outstanding. Such shares continue to be authorized shares and may be issued by the company again at a later date. Continuing the above example, it the company retires 500 common shares, its authorized shares remain at 40,000, its issued shares fall to 9,500 (10,000 – 500), and its outstanding shares fall to 9,500 (10,000 –500).
The financial effects of a company retiring its own common stock, are a decrease in resources (assets) and an equal decrease in sources of resources (stockholders' equity). Assets and stockholders' equity both decrease by the dollar amount the company pays to acquire the stock.
For example on October 11, if the company acquired the 500 common shares at a price of $5 per share, show the effects on the company's resources and sources of resources.
Total
Resources
=
Sources of
Borrowed
Resources
+
Sources of
Owner Invested
Resources
+
Sources of
Management Generated
Resources
Assets
=
Liabilities
+
Stockholders' Equity
- $2,500
cash
=
- $1,000
common stock
- $1,500additional paid-in capital, common stock
The cash payment for the 500 shares reduces the company's resources (assets) as the $2,500 cash flows out to owners (500 shares x $5 per share = $2,500). The company's sources of resources (stockholders' equity) decrease by $2,500 because the owners' rights to the company have been reduced. The common stock account was reduced by the $1,000 par value of the number of shares retired (500 shares x $2 par = $1,000). The $1,500 reduction of the additional paid-in capital, common stock account represents the elimination of the amount of additional paid-in capital, common stock originally recorded when the stock was issued to owners. Remember, the 10,000 shares were originally sold to owners at $5 per share. Thus, each common share had been issued at $3 above par ($5 per share sales price - $2 per share par = $3 additional paid-in capital). If the company had paid $4 per share to acquire the 500 shares, additional paid-in capital would have been reduced by only $1,000 [500 shares x ($4 purchase price - $2 par) = $1,000]. If the company had paid $9 per share to acquire the 500 shares, additional paid-in capital would have been reduced by $1,500 and retained earnings would have been reduced by $2,000 [500 shares x ($9 purchase price - $2 par - $3 additional paid-in capital) = $2,000]. Regardless of the specific accounts affected, the most important point of retiring common stock is the decrease in the company's resources and sources of resources. Managers are concerned about retiring stock because the process reduces the amount of resources they have to work with in the future. From an accounting standpoint, it is important to note that gains or losses are not recorded on the retiring of common stock. Since such transactions do not involve customers, but are strictly transactions between the company and its owners, any "gains or losses" affect contributed capital or retained earnings and do not appear on the income statement.
Remembering that assets increase with debits and that debits must equal credits, prepare the journal entry to record the $2,500 cash payment to retire 500 shares of the company's common stock.
Date
Description
Post.
Ref.
Debits
Credits
Oct. 11
Common Stock
1,000
Additional Paid-in Capital, Common Stock
1,500
Cash
2,500
Common stock retired
