Question

Treasury Stock Transactions—You Can’t Lose! The following is adapted from an article appearing in Forbes: The board of Hospital Corporation of America (HCA) authorized the buyback of 12 million of the firm’s own shares at a total cost of $564 million. However, after the stock market crash of 1987, HCA’s shares were trading at only 31 1/8. So, HCA was now out $190.5 million on its investment—right? Common sense would answer yes, but beyond common sense lurks the logic of accounting. According to generally accepted accounting principles, HCA didn’t lose a penny on the buyback. Call it a no-risk investment. In this era of stock market volatility, stock buybacks offer firms the opportunity to tell shareholders that they have a terrific investment—without ever having to own up to the bad news if it turns sour.

Consider the scenario given in the case evaluate the reasonableness of the accounting for treasury stocks transactions?  

Answer 1

As per Accounting principles, Treasury stock is a contra-equity account. It is not treated as an asset, because a company cannot legally invest in its own stock.Rather, treasury stock is presented on the balancesheet, where it reduces the total amount of owners' equity. As a company cannot buy its own shares for the purpose of investment , so a company having sufficient cash may decide to buy back its own shares for increasing E.P.S, to increase the promoter's holding, to distribute cash to its shareholder. Its not that company doesn't looses a penny on the buy back as the source of buyback of shares are its free reserves, securities premium and the proceeds of the issue of any shares or other specified securities. This amount is transferred in form of cash to an Bank Account.The premium paid on buy back is adjusted against securities premium and free reserves as these reserves carry realised profits in hands of the company. The company may distribute its free reserves as dividend or for any other investement proposal but company may think better to invest the amount for buyback to reduce the control of other shareholders or increase the value of remaining shares.For buyback of shares that are not conducted through stock exchange, that is, no securities transaction tax is paid, the long term capital gains are taxable so company prefers to route their buyback through the stock exchange mechanism so that normal equity shares taxation applies.Finance sees investment as only cash outflow but accounting considers its overall impact on the fiancial statements.