Question

YES/NO Questions

A Company’s CEO, Lee Ira Ontario (Nicknamed “LION”), realizes his company has too much Cash on hand. The Company has been very profitable and cash balances have become very large because of that profitability as well as the fact the company does not pay a Dividend. His total balance sheet amounts to $ 10 billion and his Cash balances are 10% of that, $ 1 billion.

The CEO realizes his Company does not have enough growth prospects or opportunities for capital expenditures in Property, Plant and Equipment. His Cash balances will lie on the balance sheet earning a sub-equity return. He decides to buy out equity investors using up to $ 500 million of cash. His investors’ Common Stock trades in a very stable range of $ 10 - $ 12 per share. The total Equity section of the Balance Sheet amounts to $ 4 billion of which the Common Stock Par and APIC accounts represent $ 1 billion, added together. There are 500 million Common Stock shares authorized, issued and outstanding. The 500 million shares represent an aggregate average contribution of $ 2 per share ($ 1 billion of Common Stock Par Value and APIC divided by 500 million shares).

It appears to the CEO that his shares are trading at a ratio of between 5:1 and 6:1 relative to contributed capital ($ 10 - $ 12 in market price per share compared to about $ 2 per share in capital contributions). The shares will not be retired or destroyed. They may be reissued.

The CEO is not good at accounting. He relies on his CFO, T.I. Gress, entirely to manage all Accounting and Treasury functions. Ms. Gress, or “TI” as she likes to be called, is a graduate of Southeastern Louisiana University where she earned a BS in Accounting and Finance (a dual major), graduating with honors and Phi Beta Kappa.

LION asks TI, “If I buy back Common Stock, up to the $ 500 million in cash authorized by the Board, don’t I have to show a loss in the Income Statement? I think the accounting is:

Debit [Income Statement] Loss XXX

Credit Cash XXX

Having said that I can’t figure out how to do the accounting for the shares. How do I treat them for accounting purposes?”

1. There is no loss in Earnings on the buyback of shares. Is this right? Yes or No

2. Common Stock bought back is recorded As Treasury Shares, a Contra-Equity Is this right? Yes or No

3. We don’t reduce Cash by what you pay. Cash held by shareholders is still Cash for us. Is this right? Yes or No

4. When we buy back the shares we must reduce the Common Stock Par Account Is this right? Yes or No.

5. I am sure I am right about one thing: You can never generate Earnings from transactions in Equity! Is this right? Yes or No.

Answer 1

1	There is no loss in Earnings on the buyback of shares. Is this right?	YES
2	Common Stock bought back is recorded As Treasury Shares, a Contra-Equity Is this right?	YES
3	We don’t reduce Cash by what you pay. Cash held by shareholders is still Cash for us. Is this right?	NO
4	When we buy back the shares we must reduce the Common Stock Par Account Is this right?	NO
5	I am sure I am right about one thing: You can never generate Earnings from transactions in Equity! Is this right?	YES