When a corporation buys back some of its shares its number of outstanding shares decreases. Once shares are reacquired they may either be retired or held as part of the corporations "treasury stock." Treasury stock shares do not have voting rights and do not pay dividends. When outstanding shares decrease, earnings per share and return on equity ratios increase. Share buybacks are also a way to return cash to shareholders. As a result of these two benefits, share buybacks now exceed dividends as a form of distribution to shareholders.1
When public companies go private, they do so by repurchasing all the outstanding publicly owned shares of the company. When management or another employee group does this by financing the purchase using the compnay's own assets as collateral, this transaction is known as a leverage buy out.
Accounting for Repurchase and Retirement
It is likely that a corporation that repurchases common shares will pay a different amount for common shares than it received upon issuing them (or their par value or stated value). When these shares are purchased to be retired, the difference between the repurchase price and their stated value should be charged to capital. The difference may be charged to retained earnings in recognition of the fact that a corporation can always capatalize or allocate retained earnings for such a purpose. If a portion of the difference is allocated to additional paid-in capital, it is limited to the sum of (a) all additional paid-in capital arising from previous retirements and net gains on sales of treasury stock of the same issue and (b) the pro rata portion of additional paid-in capital, voluntary transfers of retained earning and capitalization of stock dividends on the same issue. Any excess must be allocated to retained earnings.2
Accounting for Repurchase and Resale
There should be no difference in accounting treatement between a repurchase/retirement and issue of new shares and a repurchase to treasury stock and resale.3 The difference between the repurchase price and the resale price of a company's own stock should be accounted for as either a deduction from total capital stock, additional paid-in capital, and retained earnings.45
1. Kieso, Donal E. et al (ed). Intermediate Accounting Volume 2: Eighth Canadian Edition. Wiley: Toronto. pg 904.
2. FASB ASC 505-30-30
3. FASB ASC 505-30-25-7
4. FASB ASC 505-30-25-9
5. FASB ASC 505-30-30-6 see also 505-30-45-1.