Apple paid $62 billion to buy back its own stock during the first three quarters of 2018, but the stock’s value soon fell to $53 billion1.  It seems like Apple would need to record a $9 billion loss.

But it didn’t record any loss.

According to the accounting rules, companies never recognize a gain or a loss when dealing in their own stock.  Even if Apple sold all of the shares it had repurchased tomorrow for a single dollar, this would have zero effect on Apple’s quarterly earnings.

Why is this the case? 

Repurchased shares (known as “treasury stock” or “treasury shares”) aren’t considered an asset.  When Apple sells inventory this leads to revenue, and when it sells equipment or investments in other firms this leads to a gain or a loss.  But inventory, equipment, and investments are assets – treasury stock is a contra-equity account.

Thus, paying $62 billion cash to repurchase shares decreases a company’s assets (because cash is being paid out) and decreases the company’s stockholders’ equity (because a contra-equity account is being recognized).  The treasury shares would appear in the stockholders’ equity section of the Balance Sheet as a reduction in total equity.

The accounting hasn’t always been this way – R.J. Reynolds recognized a $15 million gain in 1933 when it re-sold shares it had previously repurchased2.  Over time, accountants agreed that this was not the correct accounting treatment:  corporations shouldn’t recognize gains or losses on treasury stock because treasury stock didn’t qualify as an asset.

Why isn’t Treasury Stock an Asset?

When you as an individual purchase shares of common stock, you generally obtain 3 things:

  1. The right to vote for the company’s board of directors
  2. The right to receive dividends, if the company issues dividends
  3. The right to receive any remaining assets if the corporation is liquidated, after the company’s creditors and preferred shareholders have satisfied their claims

A corporation that has purchase its own stock, however, receives none of these benefits3.  When Apple bought back its shares, it didn’t receive the right to vote for board members or receive dividends, and it can’t receive a distribution of itself in a liquidation.  Thus, treasury stock isn’t an asset – and no gain or loss is recognized when it is purchased or sold.

Who cares?

The Tax Cuts and Jobs Act led to a record number of stock buybacks by U.S. firms in 20184.  But the precipitous stock market decline in the 4th quarter of 2018 significant reductions in the value of the repurchased shares.  The fair value of stock repurchased by Citigroup, Wells Fargo, and Applied Materials fell by $2.8, $2.7, and $1.8 billion, respectively5.

These share repurchases actually increased companies’ earnings.  While share repurchases never lead to a gain or a loss, they reduce the number of common shares outstanding.  This boosts a company’s earnings per share, and is a reason some managers choose to repurchase shares in the first place6.  Paradoxically, a manager could increase earnings per share to receive a bonus (ref 2) while facing no downside risk; if $62 billion of repurchased stock is later sold for one dollar, the company won’t recognize a loss.

Treasury Stock Video
Why Firms Buy Back their own Stock

References:

  1. Rapoport, M., & Francis, T. (2018, December 27). The investment that cost Apple $9 billion in 2018. The Wall Street Journal. https://www.wsj.com/articles/the-investment-that-cost-apple-9-billion-in-2018-11545925184?mod=searchresults&page=1&pos=11
  1. Rankin, C. H. (1940). Treasury stock: A source of profit or loss? The Accounting Review, 15(1), 71-77.
  1. Sheldahl, T. K. (1982). Reporting treasury stock as an asset: law, logic, and economic substance. The Accounting Historians Journal, 9(2), 1-23.
  1. Eisen, B., & Otani, A. (2018, May 18). Record buybacks help steady wobbly market. The Wall Street Journal. https://www.wsj.com/articles/record-buybacks-help-steady-wobbly-market-1525950001
  1. Rapoport, M., & Francis, T. (2018, December 27). The investment that cost Apple $9 billion in 2018. The Wall Street Journal. https://www.wsj.com/articles/the-investment-that-cost-apple-9-billion-in-2018-11545925184?mod=searchresults&page=1&pos=11
  1. Sheldahl, T. K. (1982). Reporting treasury stock as an asset: law, logic, and economic substance. The Accounting Historians Journal, 9(2), 1-23.

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