Chapter 10, Problem 2EIA

Case 2. The board of directors for Atlantic Corporation met in January to address growing concerns about the declining stock price of the firm. Because the price per share was so low, the board decided that the company would buy back 10 million shares of outstanding stock. During the year, Atlantic Corporation repurchased the shares at a total cost of $62 million. With fewer shares in the hands of shareholders, the board of directors declared and paid a dividend on only those remaining shares outstanding. As a result of these activities, the price per share rose dramatically in only 10 months. The board of directors then felt it best to reissue the treasury stock at the highest share price possible. Accordingly, Atlantic Corporation reissued the 10 million shares for $142 million. When the board of directors looked over the yearly financial statements, however, it could not find the $80 million “gain” from the treasury stock sale, equal to the reissue price of $142 million less the purchase cost of $62 million. The accountant had recorded the excess as “Additional Paid-in Capital” rather than as a gain on sale. The board of directors met with the accountant and demanded that a gain be recorded; the board wanted more revenue to be included on the income statement. It argued that stock had been sold at a price higher than it was purchased for and therefore it really did not matter whether the stock was Atlantic Corporation stock or any other company's stock because all stock sales result in either a gain or loss.

Why does the board of directors want to recognize the $80 million excess from the treasury stock transactions as a gain? Why does the accountant want to recognize the $80 million as an increase in total equity? Who is right? Are any ethical issues involved? Does the board of directors have a strong argument that it does not matter whether the stock was Atlantic Corporation stock or any other company because all stock is the same? Do you have any additional thoughts?