Introduction:
Treasury stock is the share or stock that is repurchased by the company that issued them in the first place.
It reduces the paid-up capital and is also known as equity reduction. Treasury stock is recorded in the equity section of the balance sheet.
For example, a company has a paid-up capital of $200,000. It decides to repurchase 3000 shares at a value of $25. This means that the company will pay $75,000 to the existing shareholders and purchase back its stock.
The equity section will be reduced by $75,000 and would have a remaining balance of $125,000.
Simultaneously, the cash or cash equivalents balance would also be reduced by $75,000 in the balance sheet.
Statement of Cash flow:
A cash flow statement is a financial statement that should be prepared as per IAS 07 by all companies annually.
It reports all the cash transactions that take place during a specific period of time (a month, a quarter, or a year) and excludes any non-cash revenues or expenses recorded in the income statement.
A statement of cash flow accounts for every penny received or paid during the year and gives a clearer view of the financial stability and liquidity of a company.
According to the International Accounting Standards, a cash flow statement is to be prepared in the specified format so that it is easily understandable to any reader around the world. It is to be classified into three main heads as follows:
- Operating Activities
- Investing Activities
- Financing Activities
Cash flow from operating activities accounts for all the principle transactions relating to the trading business. It includes any adjustments relating to operating expenses and working capital adjustments.
Cash flow from investing activities involves any cash or cash equivalents spent on investments, gains or losses from investments, purchase or disposal of property, plant, and equipment.
Cash flow from financing activities reports transactions relating to cash for funding the company through debt or equity and also involves payment of dividends.
It involves cash inflow or outflow from issuance or repurchase of equity, obtaining a loan or repayment of the loan, issuing bonds, or payment of dividends.
Effect of treasury stock on statement of cash flow:
As mentioned above, treasury stock is a contra account of equity and involves the repurchase of the issued stock. In order to repurchase stock, the company has to make payments to the existing shareholders resulting in a cash outflow.
This transaction is reported in the financing activities section of the cash flow statement.
Similarly, if there is a sale of treasury stock, the company receives cash or cash equivalents against the shares from the new shareholder.
This is reported as a cash inflow in the financing activities section of the statement of cash flow.
Example 1:
A company has an equity balance of $25,000 for the fiscal year ended 2018. In 2019, the company repurchases 500 shares from its issued capital at a value of $10.
This would result in a reduction of equity from $25,000 to $20,000 in the balance sheet.
The cash outflow of $5,000 would be reported under the third section of the statement of cash flow i.e. cash flow from financing activities as follows:
Cash flow from financing activities: $
Purchase of treasury stock (5,000)
Net cash flow from financing activities (5,000)
Example 2:
A company has an equity balance of $100,000 which includes a treasury stock balance of $20,000 for the year ended 2018.
In 2019, the company decides to sell all its treasury stock and receives an amount of $20,000 against it.
This transaction increases the equity balance in the balance sheet for the year ended 2019 to $120,000 and the treasury stock account is reduced to zero.
In the cash flow statement, a cash inflow of $20,000 is reported in the financing activities section for the year ended 2019 in the following manner:
Cash flow from financing activities: $
Sale of treasury stock 20,000
Net cash flow from financing activities 20,000
