5) Treasury Stock — Par Value Method

The resale of treasury stock is recorded by debiting cash account for the actual amount received, crediting treasury stock for the par value of the treasury shares and if the cash received on resale is:

• more than the total par value of treasury shares, the excess is credited to additional paid-in capital account.

• less than the total par value of treasury shares, the difference is debited to additional paid-in capital from treasury stock provided it has sufficient credit balance otherwise retained earnings account is debited.

The following example shows the journal entries to record the purchase and resale of treasury stock under par value method.

Example

A corporation issued 12,000 shares of common stock of $4 par value and received $57,000 from investors. It then bought back 1,000 of the shares and paid a sum of $4,500 for the purchase. Later it resold 500 of the treasury shares at a price of $5 per share.

Journalize the above transactions according the par value method of accounting for treasury stock.

Solution

Issuance of Common Stock:

Cash	57,000
Common Stock		48,000
Additional Paid-In Capital		9,000

Purchase of Treasury Stock (Par Value Method):

Treasury Stock	4,000
Additional Paid-in Capital1	750
Cash		4,500
Add. Paid-in Capital from TS2		250

1: 9,000 × (1,000 ÷ 12,000)

2: 4,000 + 750 − 4,500

Resale of Treasury Stock (Par Value Method):

Cash	2,500
Treasury Stock		2,000
Additional Paid-In Capital		500

6) What is retained earnings?

Generally, retained earnings is a corporation’s cumulative earnings since the corporation was formed minus the dividends it has declared since it began. In other words, retained earnings represents the corporation’s cumulative earnings that have not been distributed to its stockholders.

The amount of retained earnings as of a balance sheet’s date is reported as a separate line item in the  stockholders’ equity section of the balance sheet.

A negative amount of retained earnings is reported as deficit or accumulated deficit.

Example

IG Plc. has a balance in retained earnings as at 1 January 2011 of $102 million. It earned a net income of $40 million for the year and declared dividends of $45 million in the year.

The statement of retained earnings would look like as follows:

Retained earnings as at 1 January 2011
Plus: net income for the period
Less: dividends declared
Retained earnings as at 31 December 2011

7) Does a dividend reduce profit?

When a corporation declares and pays a dividend, the dividend does not reduce the current accounting period’s profit reported on the income statement. In other words, a dividend is not an expense.

Dividends will reduce the amount of the corporation’s retained earnings. Retained earnings are reported in the stockholders’ equity section of the balance sheet.

If a corporation has very profitable uses for its cash, its future profits might be less if it pays dividends instead of reinvesting the cash dividend amounts into profitable projects.