Treasury Stock

Treasury stock sits between those definitions. Treasury shares were issued, because the company sold them to shareholders at some point. They are no longer owned by shareholders, because the company bought them back. They are therefore issued but not outstanding.

A hypothetical shows how the counts relate. Suppose a company's organizational documents authorize ten million shares, and the company has issued six million of them. The company later repurchases five hundred thousand shares and holds them as treasury stock. The company then has six million shares issued, five hundred thousand held in treasury, and five and a half million outstanding. Four million shares remain authorized but have never been issued. This illustration does not describe any actual company.

The distinction matters because many measures depend on which count is used. The shares held by shareholders are the outstanding shares, and the treasury shares are held by the company itself.

How a Company Comes to Hold Treasury Stock

The usual route is a repurchase, which is also called a buyback. A company decides to use its cash to buy some of its own shares from shareholders. The purchase can be made in the market, where the company buys the way any other buyer would, or through a tender offer, in which the company invites shareholders to sell their shares at stated terms. FINRA's content outline for the Securities Industry Essentials examination lists buybacks and tender offers among the types of corporate actions that a candidate studies.

After the company has bought the shares, it chooses what to do with them. It can cancel them, in which case they cease to exist as issued shares. Or it can hold them as treasury stock. Held shares can later be reissued, for example to shareholders in a new sale, to employees under a compensation plan, or in an acquisition. The legal and accounting consequences of each choice are different, and they depend on the law of the state of incorporation.

What Corporate Law Says

Corporate law is set by each state, and the statutes do not treat treasury stock in the same way. Three examples show the range.

Delaware's General Corporation Law, in Section 160, gives a corporation the power to purchase, redeem, receive, take or otherwise acquire, own and hold, sell, lend, exchange, transfer or otherwise dispose of its own shares. It limits that power. A corporation may not purchase or redeem its own shares of capital stock for cash or other property when the capital of the corporation is impaired or when the purchase or redemption would cause any impairment of the capital. The section also provides that shares of a corporation's capital stock shall neither be entitled to vote nor be counted for quorum purposes if the shares belong to the corporation. A company that holds its own shares therefore cannot use them to vote, and they are not counted when deciding whether a quorum is present.

New York's Business Corporation Law, in Section 515, addresses reacquired shares directly. It provides that shares that have been issued and then purchased, redeemed or otherwise reacquired shall be cancelled if they are reacquired out of stated capital, if they are converted shares, or if the certificate of incorporation requires cancellation. Any other reacquired shares may be retained as treasury shares or cancelled. The statute adds that neither the retention of reacquired shares as treasury shares, nor their later distribution to shareholders or disposition for consideration, changes the stated capital.

Other states take a different approach. New Hampshire's business corporation act, in Section 6.31, provides that a corporation may acquire its own shares and that shares so acquired constitute authorized but unissued shares. Under that approach, reacquired shares go back into the pool of shares that can be issued, and there is no separate category called treasury stock. The statute adds that if the articles of incorporation prohibit the reissue of acquired shares, the number of authorized shares is reduced by the number acquired.

The result is that whether a company has treasury stock in the legal sense depends on the state in which it is incorporated. Accounting guidance, which is separate from state corporate law, nonetheless describes treasury stock as one of the ways a company may account for repurchased shares.

One Repurchase Under Three Statutes

A single hypothetical shows how much depends on the state of incorporation. Suppose three companies, each incorporated in a different one of the states discussed above, repurchase one hundred thousand of their own shares.

The company incorporated in Delaware may hold the shares, because the statute gives it the power to own and hold its own shares, provided the purchase did not impair its capital. While it holds them, the shares are neither entitled to vote nor counted for quorum purposes.

The company incorporated in New York may keep the one hundred thousand shares as treasury shares or cancel them, unless the statute, its certificate of incorporation or the source of the funds requires cancellation. If it keeps them as treasury shares, the statute provides that the retention does not change the stated capital.

The company incorporated in New Hampshire does not end up with treasury shares in the statutory sense. The shares it acquires constitute authorized but unissued shares, so the one hundred thousand shares return to the pool of shares that the company is authorized to issue and has not issued. If its articles of incorporation prohibit reissue, the number of authorized shares falls by one hundred thousand.

The three companies have done the same thing in business terms, which is to buy back shares. The legal status of the shares afterward differs. This illustration is a simplification and does not describe any actual company.

How Treasury Stock Is Recorded

Accounting guidance published by one of the major accounting firms explains the treatment. A reporting entity should recognize treasury stock based on the amount paid to repurchase its shares, which is the cost method. Treasury stock is recorded as a reduction of stockholders' equity, as a contra-equity account, and the cost can be shown separately as a deduction from the total of capital stock, additional paid-in capital and retained earnings.

Two points follow. First, treasury stock is not an asset. A company that buys its own shares has not acquired something that appears on the left side of the balance sheet. It has used cash, and the use of cash is reflected as a reduction in equity. Second, because the treasury stock is a reduction of equity, a repurchase reduces total stockholders' equity by the amount paid.

A hypothetical shows the recording. Suppose a company repurchases one hundred thousand of its shares at twenty dollars a share, paying two million dollars in total. Under the cost method, treasury stock of two million dollars is recorded as a reduction of stockholders' equity, and cash falls by two million dollars.

The same guidance explains what happens when treasury shares are sold again. When treasury shares are reissued above cost, the gain is recorded in additional paid-in capital. When they are reissued below cost, a loss may be debited to additional paid-in capital to the extent that previous net gains from sales or retirements of the same class of stock are included in additional paid-in capital, and any losses in excess of that amount are charged to retained earnings. These gains and losses are recognized in shareholders' equity and not in net income.

Return to the hypothetical. Suppose the company reissues forty thousand of the treasury shares at twenty-five dollars a share. It receives one million dollars. The cost of those forty thousand shares is eight hundred thousand dollars, so the difference of two hundred thousand dollars is recorded in additional paid-in capital, and no profit appears in net income. Suppose instead it reissues the forty thousand shares at fifteen dollars a share and receives six hundred thousand dollars. The shortfall of two hundred thousand dollars is charged first to additional paid-in capital, to the extent earlier net gains of the same class are in that account, and then to retained earnings. No loss appears in net income. These figures are illustrations only.

A company that retires its repurchased shares does not hold them in treasury, and the accounting differs from the treasury stock method. The guidance cited above addresses retirement separately.

How Treasury Stock Appears on a Balance Sheet

The accounting guidance described above says that the cost of treasury stock can be shown separately as a deduction from the total of capital stock, additional paid-in capital and retained earnings. In practice, a balance sheet presents the treasury stock as a negative line within the equity section.

A hypothetical equity section illustrates the layout. Suppose a company reports common stock and additional paid-in capital of fifty million dollars and retained earnings of thirty million dollars. It also reports treasury stock at cost of two million dollars. The treasury stock is deducted from the total of eighty million dollars, so total stockholders' equity is seventy-eight million dollars. The company's total assets are lower than before the repurchase by the cash it spent, and its equity is lower by the same amount. This illustration does not describe any actual company.

Rules Governing the Repurchases

A repurchase in the market raises a particular concern. A company that buys its own shares can affect the market for them, so the SEC has provided a safe harbor in SEC Rule 10b-18. Rule 10b-18 provides issuers and affiliated purchasers with a safe harbor from liability for manipulation under Section 9(a)(2) of the Securities Exchange Act of 1934 and Rule 10b-5 when repurchasing common stock in compliance with four conditions.

The first condition concerns the manner of purchase. Rule 10b-18 purchases must be effected from or through only one broker or dealer on any single day. The second concerns timing. The purchases may not be the opening transaction of the day and are restricted during a period shortly before the close of the market, which varies with the size of the security. The third concerns price. A Rule 10b-18 purchase must be effected at a price that does not exceed the highest independent bid or the last independent transaction price. The fourth concerns volume. The total volume of Rule 10b-18 purchases by or for the issuer and any affiliated purchasers on any single day must not exceed twenty-five percent of the average daily trading volume of the security.

A safe harbor is a protection and not a requirement. Not meeting the four conditions does not by itself establish that a repurchase is manipulative. It means only that the safe harbor is not available as protection for that repurchase.

What Must Be Disclosed

Repurchases are disclosed to investors. Item 703 of Regulation S-K requires an issuer to disclose, in a table, any purchase made by or on behalf of the issuer or any affiliated purchaser of its registered equity securities. The table has four columns of information. The columns show the total number of shares purchased, the average price paid per share, the total number of shares purchased as part of publicly announced repurchase plans or programs, and the maximum number, or approximate dollar value, of shares that may yet be purchased under those plans or programs. The table is organized by month and identifies the beginning and ending dates of each month, with a total for the period.

A shareholder who reads the table can see how many shares a company bought, at what average price, and how much room remains under the company's announced program.

Where Investors Can Find the Information

A reader who wants to know whether a company holds treasury stock can look in several places. The equity section of the balance sheet shows the treasury stock at cost, if the company accounts for repurchased shares this way. The company's periodic reports include the table required by Item 703 of Regulation S-K, which shows monthly repurchases and the amount that may yet be purchased under announced programs. The cover pages and equity notes of the company's filings state the number of shares outstanding, which excludes treasury shares.

A careful reader compares the number of shares issued with the number of shares outstanding. The difference between the two is the number of shares the company holds in treasury.

The Federal Excise Tax on Repurchases

Since 2023, repurchases by certain corporations carry a federal excise tax. The instructions to IRS Form 7208 explain that the tax is equal to one percent of the fair market value of stock repurchased during the tax year. A covered corporation is one whose stock is traded on an established securities market. The tax applies to repurchases occurring after 2022 under the Inflation Reduction Act of 2022. A repurchase for this purpose is a redemption within the meaning of section 317(b) of the Internal Revenue Code and any transaction determined by the Secretary to be economically similar to such a redemption. The form also requires the corporation to subtract stock issued to employees and contributed to retirement plans from its total repurchases before applying the rate.

The tax is imposed on the repurchase. It does not depend on whether the company later cancels the shares or holds them as treasury stock.

Treasury Stock Compared With Related Terms

Several terms sit close to treasury stock, and the differences are worth keeping straight.

Authorized but unissued shares are shares a company is permitted to issue under its organizational documents and has not issued. They have never been sold to shareholders. Treasury shares have been issued and then reacquired.

Retired or cancelled shares are shares that a company has reacquired and then cancelled. They no longer exist as issued shares. Treasury shares still exist and are held by the company. Whether reacquired shares are cancelled or held depends on the choice the company makes, subject to the law of the state of incorporation, which in some states requires cancellation in particular circumstances.

Outstanding shares are issued shares that are still owned by shareholders. Treasury shares are not owned by shareholders and are not outstanding.

A share repurchase is the transaction by which a company buys its own shares. Treasury stock is one status that the repurchased shares can take afterward. A company can repurchase shares and cancel them without ever holding treasury stock.

What Treasury Stock Means for Shareholders

Treasury stock affects the shareholders who remain in several ways.

The first is the share count. Treasury shares are not outstanding, so a company that repurchases shares has fewer outstanding shares after the purchase than before. Each remaining outstanding share represents a larger fraction of the company's ownership, because the total number of shares held by shareholders is smaller. In the earlier hypothetical, one share out of five and a half million outstanding represents a larger fraction than one share out of six million.

The second is voting. Under the Delaware provision described above, shares belonging to the corporation are neither entitled to vote nor counted for quorum purposes. The votes that shareholders cast are therefore a larger part of the votes that can be cast.

The third is any measure that is calculated using outstanding shares. When a company reports a figure per share and the calculation uses the number of shares outstanding, a smaller count of outstanding shares changes the result. A reader should check the share count that underlies any per-share figure.

The fourth is the company's cash. A repurchase uses cash. The company that spends cash on buying back shares has less cash available for other uses, and the repurchase reduces stockholders' equity by the amount paid.

The Term in Exam Preparation

FINRA's content outline for the Securities Industry Essentials examination lists buybacks among the types of corporate actions that a candidate studies, and treasury stock is the status that bought-back shares can take. A learner preparing for that examination can review the course overview for the Securities Industry Essentials examination to see how corporate actions fit with the rest of the outline.

Common Misunderstandings

One misunderstanding is that treasury stock is stock of the United States Treasury. It is stock of the company itself that the company has reacquired and holds.

A second misunderstanding is that treasury stock is an asset. Accounting guidance treats it as a reduction of stockholders' equity and not as an asset.

A third misunderstanding is that treasury shares are outstanding. They are issued but not outstanding, because outstanding shares are those still owned by shareholders.

A fourth misunderstanding is that treasury shares vote. Under the Delaware provision described above, shares belonging to the corporation are neither entitled to vote nor counted for quorum purposes.

A fifth misunderstanding is that every state recognizes treasury stock. Some statutes, including the New Hampshire provision described above, provide that shares a corporation acquires constitute authorized but unissued shares.

A sixth misunderstanding is that a company can show a profit by reselling treasury stock above the price it paid. Under the accounting guidance described above, a gain on reissuance is recorded in additional paid-in capital and not in net income.

A seventh misunderstanding is that the safe harbor in Rule 10b-18 is a requirement for every repurchase. It is a protection that applies when the four conditions are met, and the conditions are not themselves a rule that all repurchases must follow.

Key Points

Treasury stock is stock that a corporation has issued and later reacquired and holds. It is issued but not outstanding, and it is not the same as authorized but unissued stock.

State law differs. Delaware provides that shares belonging to the corporation are neither entitled to vote nor counted for quorum purposes. New York permits reacquired shares to be held as treasury shares or cancelled. New Hampshire provides that acquired shares constitute authorized but unissued shares.

Under accounting guidance, treasury stock is recognized at cost and recorded as a reduction of stockholders' equity, and gains or losses on reissuance are recognized in equity and not in net income.

Rule 10b-18 offers a safe harbor for market repurchases when the manner, timing, price and volume conditions are met, Item 703 of Regulation S-K requires a monthly table of repurchases, and a federal excise tax of one percent applies to repurchases by covered corporations after 2022.