Chapter 13, Problem 6BTN

To determine

Introduction: Treasury stock is the stock which is bought back by a company and company keeps these shares as own treasury. Treasury stock may come from a repurchase or buyback from shareholders, or it may have never been issued to the public in the first place.

Requirement – 1a:

To calculate: Impact of stock buyback on the financial position.

Answer to Problem 6BTN

Solution:

Followings are the main impact of stock buyback on the financial position;

1. It reduces the number of outstanding shares.

2. It improves the EPS.

3. It results into higher share price.

4. It reduces cash holding in the balance sheet.

5. It reduces shareholders’ equity in the balance sheet.

Explanation of Solution

Explanation:

Followings are the main impact of stock buyback on the financial position;

1. It reduces the number of outstanding shares;

Due to buyback of shares, number of outstanding shares will be reduced. As we know that treasury stock is deducted from issued shares that is why in the balance sheet number of shares outstanding will be reduced by the number of treasury stock buyback.

2. It improves the EPS;

As number of shares outstanding reduces then available net income will be distributable amongst lower number of outstanding shares hence EPS will improve.

3. It results into higher share price;

Due to buyback of shares, market price of the shares will improve because supply of shares will be lower in compare to demand hence prices of the shares will be higher.

4. It reduces cash holding in the balance sheet;

At the time of buyback of shares, a company pay cash to the shareholders hence available cash balance in the balance sheet will be reduced.

5. It reduces shareholders’ equity in the balance sheet;

Treasury stock is deducted from shareholders’ equity hence as a result balance of shareholders’ equity will be reduced.

Conclusion

Thus, above mentioned are the major impact of stock buyback on the financial position of a company.

To determine

Requirement – 1b:

To calculate:Why a company engage in stock buyback?

Answer to Problem 6BTN

Solution:

A company normaly engage in stock buyback due to following reasons;

1. For reducing overall cost of capital.

2. For improving return on the shares.

3. For improving condition of undervalued stock.

4. For improving earnings per share.

5. For using excess cash balance in the hand.

6. For taking tax advantages.

Explanation of Solution

Explanation:

A company normally engage in stock buyback due to following reasons;

1. For reducing overall cost of capital;

As we know that dividends paid to shareholders is the cost for a company so through buyback of shares a company can reduce number of outstanding shares hence as a result dividends to be paid will be lower. Thus it will result into lower of overall cost of capital.

2. For improving return on the shares;

With the help of buyback of shares, number of outstanding shares can be reduced hence it will help in improving eraning per share.

3. For improving condition of undervalued stock

Company can improve value of shares with the help of buyback of shares because in case of undervalued shares company buyback its’ own shares and in case higher it sells these shares.

4. For using excess cash balance in the hand;

If a company have excess cash in the hand and there is no fair investment option then company can use this excess cash balance for buyback of shares.

6. For taking tax advantages;

Dividends paid is subject to taxataion hence for reducing tax burden a company go goy buyback of shares because in case of buyback company can use its’ surplus cash.

Conclusion

Thus, above mentioned are the reasons for engaging in stock buyback.

To determine

Requirement – 2:

To calculate:Journal entries for stock buyback.

Answer to Problem 6BTN

Solution:

S. No.	Accounts Title & Explanation	Debit	Credit
(1).	Treasury Stock	$13400
	Cash		$13400
	(To record purchase of common stock at cost)
(a).	Cash	$13400
	Treasury Stock		$13400
	(To record re-issue of treasury stock)
(b).	Cash	$15000
	Treasury Stock		$13400
	Additional paid in capital – Treasury Stock		$1600
	(To record re-issue of treasury stock)
(c).	Cash	$12000
	Additional paid in capital – Treasury Stock	$1400
	Treasury Stock		$13400
	(To record re-issue of treasury stock)
(d).	Cash	$12000
	Additional paid in capital – Treasury Stock	$1000
	Retained earnings	$400
	Treasury Stock		$13400
	(To record re-issue of treasury stock)
(e).	Cash	$12000
	Retained earnings	$1400
	Treasury Stock		$13400
	(To record re-issue of treasury stock)

Explanation of Solution

Explanation:

S. No.	Accounts Title & Explanation	Debit	Credit
(1).	Treasury Stock (100 * $134)	$13400
	Cash		$13400
	(To record purchase of common stock at cost)
(a).	Cash (100 * $134)	$13400
	Treasury Stock		$13400
	(To record re-issue of treasury stock)
(b).	Cash (100 * $150)	$15000
	Treasury Stock (100 * $134)		$13400
	Additional paid in capital – Treasury Stock ($15000 - $13400)		$1600
	(To record re-issue of treasury stock)
(c).	Cash (100 * $120)	$12000
	Additional paid in capital – Treasury Stock (100 * $14)	$1400
	Treasury Stock (100 * $134)		$13400
	(To record re-issue of treasury stock)
(d).	Cash (100 * $120)	$12000
	Additional paid in capital – Treasury Stock	$1000
	Retained earnings ($13400 - $12000 - $1000)	$400
	Treasury Stock (100 * $134)		$13400
	(To record re-issue of treasury stock)
(e).	Cash (100 * $120)	$12000
	Retained earnings ($13400 - $12000)	$1400
	Treasury Stock (100 * $134)		$13400
	(To record re-issue of treasury stock)

Conclusion

Thus, above given are the journal entries in various cases.

To determine

Requirement – 3:

To discuss: Differences & similarities in journal entries under various cases?

Answer to Problem 6BTN

Solution:

(1). Similarities and differences between (a) and (b);

So on the basis of above two entry it is clear that in case of (a) treasury stock is reissued at cost value whereas in case of (b) treasury stock is reissued more than cost value that is why additional paid in capital account is credited with the excess value $1600. So cash account debited in both case will differ due to receipt of different amount for reissue. Value of treasury stock credited will be same in both case that is cost of treasury stock.

(2). Similarities and differences between (b) and (c);

So on the basis of above two entry it is clear that in case of (b) treasury stock is reissued at more than cost value whereas in case of (c) treasury stock is reissued less than cost value that is why additional paid in capital account is credited with the excess value $1600 in case of (b) wheras additional capital account is debited in case of (c). So cash account debited in both case will differ due to receipt of different amount for reissue. Value of treasury stock credited will be same in both case that is cost of treasury stock.

(3). Similarities and differences between (c) and (d);

So on the basis of above two entry it is clear that in case of (c) treasury stock is reissued at less than cost value whereas in case of (d) treasury stock is also reissued less than cost value that is why additional paid in capital account is debited. In case of (b) there is adequate balance in additional paid in capital account to cover loss on reissue but in case of (d) there is no adequate balance available in additional paid in capital account that is why retained earnings account is also debited with $400. So cash account debited in both case will differ due to receipt of different amount for reissue. Value of treasury stock credited will be same in both case that is cost of treasury stock.

(4). Similarities and differences between (d) and (e);

So on the basis of above two entry it is clear that in case of (d) treasury stock is reissued at less than cost value whereas in case of (e) treasury stock is also reissued less than cost value. In case of (d) there is not adequate balance in additional paid in capital account to cover loss on reissue that is why additional paid in capital account and retained earnings accounts both are debited. In case of (e) there is no balance available in additional paid in capital account that is why retained earnings account is debited with $1400. So cash account debited in both case will differ due to receipt of different amount for reissue. Value of treasury stock credited will be same in both case that is cost of treasury stock.

Explanation of Solution

Explanation:

Let’s see differences and similarities in all cases from (a) to (e) with the help of pair of two entries;

(1). Similarities and differences between (a) and (b);

(a).	Cash (100 * $134)	$13400
	Treasury Stock		$13400
	(To record re-issue of treasury stock)
(b).	Cash (100 * $150)	$15000
	Treasury Stock (100 * $134)		$13400
	Additional paid in capital – Treasury Stock ($15000 - $13400)		$1600
	(To record re-issue of treasury stock)

So on the basis of above two entry it is clear that in case of (a) treasury stock is reissued at cost value whereas in case of (b) treasury stock is reissued more than cost value that is why additional paid in capital account is credited with the excess value $1600. So cash account debited in both case will differ due to receipt of different amount for reissue. Value of treasury stock credited will be same in both case that is cost of treasury stock.

(2). Similarities and differences between (b) and (c);

(b).	Cash (100 * $150)	$15000
	Treasury Stock (100 * $134)		$13400
	Additional paid in capital – Treasury Stock ($15000 - $13400)		$1600
	(To record re-issue of treasury stock)
(c).	Cash (100 * $120)	$12000
	Additional paid in capital – Treasury Stock (100 * $14)	$1400
	Treasury Stock (100 * $134)		$13400
	(To record re-issue of treasury stock)

So on the basis of above two entry it is clear that in case of (b) treasury stock is reissued at more than cost value whereas in case of (c) treasury stock is reissued less than cost value that is why additional paid in capital account is credited with the excess value $1600 in case of (b) wheras additional capital account is debited in case of (c). So cash account debited in both case will differ due to receipt of different amount for reissue. Value of treasury stock credited will be same in both case that is cost of treasury stock.

(3). Similarities and differences between (c) and (d);

(c).	Cash (100 * $120)	$12000
	Additional paid in capital – Treasury Stock (100 * $14)	$1400
	Treasury Stock (100 * $134)		$13400
	(To record re-issue of treasury stock)
(d).	Cash (100 * $120)	$12000
	Additional paid in capital – Treasury Stock	$1000
	Retained earnings ($13400 - $12000 - $1000)	$400
	Treasury Stock (100 * $134)		$13400
	(To record re-issue of treasury stock)

So on the basis of above two entry it is clear that in case of (c) treasury stock is reissued at less than cost value whereas in case of (d) treasury stock is also reissued less than cost value that is why additional paid in capital account is debited. In case of (b) there is adequate balance in additional paid in capital account to cover loss on reissue but in case of (d) there is no adequate balance available in additional paid in capital account that is why retained earnings account is also debited with $400. So cash account debited in both case will differ due to receipt of different amount for reissue. Value of treasury stock credited will be same in both case that is cost of treasury stock.

(4). Similarities and differences between (d) and (e);

(d).	Cash (100 * $120)	$12000
	Additional paid in capital – Treasury Stock	$1000
	Retained earnings ($13400 - $12000 - $1000)	$400
	Treasury Stock (100 * $134)		$13400
	(To record re-issue of treasury stock)
(e).	Cash (100 * $120)	$12000
	Retained earnings ($13400 - $12000)	$1400
	Treasury Stock (100 * $134)		$13400
	(To record re-issue of treasury stock)

So on the basis of above two entry it is clear that in case of (d) treasury stock is reissued at less than cost value whereas in case of (e) treasury stock is also reissued less than cost value. In case of (d) there is not adequate balance in additional paid in capital account to cover loss on reissue that is why additional paid in capital account and retained earnings accounts both are debited. In case of (e) there is no balance available in additional paid in capital account that is why retained earnings account is debited with $1400. So cash account debited in both case will differ due to receipt of different amount for reissue. Value of treasury stock credited will be same in both case that is cost of treasury stock.

Conclusion

Thus, above mentioned are the similarities and differences between various cases.