When investigating a company's balance sheet, you might come across a shareholders' equity account named "Treasury Stock." This account holds shares of stock repurchased by the company. Corporations may repurchase some of their outstanding shares when they have excess cash and management thinks the market is undervaluing their stock. According to finance Professor David Ikenberry of the University of Illinois at Urbana-Champaign, on average, stock prices rise after a stock repurchase.
1. Obtain a company balance sheet for the time period under analysis. A balance sheet serves as the company's snapshot of asset, liability and stockholders' equity accounts at certain points in time. U.S. generally accepted accounting principles (GAAP) rules define the balance sheet format. Accountants classify assets and liabilities on the balance sheet as current or non-current. The "current" designation represents assets and liabilities that the firm liquidates or pays, respectively, within one year. Stockholders' equity represents the equity stake held by the corporation's investors.
2. Locate the stockholders' equity section and treasury stock account at the bottom of the balance sheet. Stockholders' equity holds several accounts including common stock, retained earnings, other comprehensive income, paid-in capital and treasury stock. Treasury stock represents the variance between a company's shares issued versus outstanding.
3. Familiarize yourself with the contra-account methodology. Even though the treasury stock account resides in the stockholders' equity section of the balance sheet, it acts as a deduction from the stockholders' equity balance. As treasury stock increases, the account balance becomes a larger negative, or debit balance. This offsets the normal credit balance of retained earnings and common shares. Each time a corporation repurchases its stock, the accountant debits, or increases, the negative balance of the treasury stock account, and credits, or decreases, the cash account.
4. Review the treasury stock account in the stockholders' equity section of the balance sheet. The account shows the current balance at the date of the balance sheet report. To view activity in the treasury stock account from one period to another, you must review balance sheets from several consecutive periods and subtract the change from one period to the next to isolate each period's activity.