This past week Boeing Company announced besides an
increase in dividend, to buy back $10 billion in shares and as a result its
share price rose 2% on the New York Stock Exchange. The chairman of Boeing
said, according to Reuters, that the share repurchase was in addition to the
$800 million remaining from the stock repurchase in 2007.
Why do companies announce that they would buy back
their own stock (treasury stock)? Well it serves several purposes and I will
explain what it means in the accounting sense. First of all, an announcement to
buy back $10 billion creates demand for the company’s stock, and on Monday the
share price did in fact increase. It also increases the market value. By “calling”
back such a huge quantity of stock, the company reduces the number of shares outstanding
and at the same time its earnings per share (EPS) increases.
Stock repurchase do not give rise to gains or losses
on the Income Statement, and subsequently have no effect on Net Income. Any
differences that arise between the purchase price of the treasury stock and the
reissue price is recorded as an increase or decrease in the additional paid in
capital account (APIC). Furthermore, purchase and sales of treasury stock
affect cash flow.
From the balance sheet, and specifically from the cash
flow statement, if one looks at the sources and uses of funds that companies use,
there are three sources: cash flow from investing activities, from financing,
and cash flow from operating activities. When corporations announce a stock
repurchase, because it is considered financing, cash flow from financing is
decreased by the amount paid by the company to buy back its shares. And if the
company reissues its stock, cash flow is increased by the proceeds it collects.
From the accounting sense, repurchasing shares are
carried in the treasury stock contra shareholders’ equity account. If the
company decides to reissue stock, then it would be removed from the treasury
account at the original price it paid to repurchase its shares.
The journal entry for the stock repurchase on the company’s
books would be to debit the treasury stock account, which is an increase in the
contra equity account, namely the treasury stock, and credit cash, by $10
billion, which is a decrease in an asset (since cash is decreasing from
repurchasing the shares).
When the company decides to retire its treasury stock,
its common stock outstanding would decrease, thus the shareholders equity
account decreases, and that would show as a debit on the accounting books. Its
treasury stock account would be credited at the original cost, and in order to
balance the t accounts, it would debit the APIC account as a plug in.
