Accounting for Treasury Shares

SEC-EAD * OPINION ACCOUNTING FOR TREASURY SHARES When a corporation reacquires its issued and fully paid shares of stock from its stockholders or from the stock market, the shares acquired are known as treasury shares. Treasury shares are recorded at cost and may again be disposed of for a reasonable price as may be determined by the Board of Directors. llcd The acquisition and disposition of treasury shares are regulated by the SEC Rules Governing Redeemable and Treasury Shares. These rules are prefaced with the provision that the outstanding capital stock of a corporation shall constitute a trust fund held by the corporation for the benefit of its creditors. Corollary to this, unless otherwise provided for under the SEC rules, a corporation cannot validly acquire its outstanding shares in treasury unless it has an adequate amount of unrestricted retained earnings to support the cost of the treasury shares. The reason for the presence of unrestricted retained earnings is understandable. This means that when treasury shares are acquired, the cost of such shares is paid out of unrestricted retained earnings, as a consequence of which, capital stock is preserved. Accordingly, the amount of unrestricted retained earnings used to purchase the treasury shares shall then be restricted from being distributed as dividends until such time that the treasury shares are disposed of or retired in accordance with law. The disposition of treasury shares, however, is a matter that requires clarification insofar as the accounting procedure is concerned. Under the Generally Accepted Accounting Principles or GAAP, the sale of treasury shares is regarded as a capital transaction and, therefore, any gain that may be realized therefrom is treated as additional paid-in capital and the loss that may be incurred is treated as a deduction from paid-in capital. If no paid-in capital is on record, then the loss is charged against operations. The SEC, however, considers sale of treasury shares from another view point. Under its rules, treasury shares do not revert to the unissued shares of a corporation but are regarded as property acquired by the corporation. Thus, when treasury shares are issued as dividend, the SEC rules likewise provide that such dividend shall be disclosed and properly designated as property dividend in the books of the corporation and on its financial statements. Conformably with the SEC rules, the sale of treasury shares should be considered as a sale of an ordinary property of the corporation such that the gain or loss that results therefrom is treated as income or loss from operations. When outstanding shares are acquired in treasury, their issued status is not disturbed. These are still part of the issued capital stock although no longer outstanding. This is so because the amount paid for the acquisition of treasury shares does not represent return of capital to the stockholders but an investment out of retained earnings on a salable property known as treasury shares. Hence, the sale of treasury shares cannot be regarded as a capital transaction since such transaction is not meant to raise additional capital but to recover what was previously paid for the said shares. The view that gain on sale of treasury shares is income is supported by the BIR Regulation No. 2 implementing the National Internal Revenue Code, which provides that gain on sale of treasury shares is income which is subject to tax. Authored by: OTILIO C. SANDIEGO Director of the Examiners and Appraisers Department Footnotes * Examiners and Appraisers Department; now Company Registration and Monitoring Department