Question

Murray Company reports net income of $770,000 for the year. It has no preferred stock, and its weighted-average common shares outstanding is 280,000 shares. Compute its basic earnings per share.

Answer 1

Treasury stock

Shares purchased back by a company are called treasury stock. A company purchase its’ shares back for different reasons like to buy another company with the help of treasury stock, issue these stock as compensation to its employees, to avoid any takeover situation by a competitor etc. Treasury stocks are alike unissued stocks which does not have voting rights, dividend are not paid, not reported as assets etc. It also called stock buyback.

When treasury stocks are purchased, it reduces the assets amount of a company because cash is paid to acquire the own shares from the market. Total equity is also reduced because treasury stocks amount is deducted from the sum total of common stock and retained earnings balance in the balance sheet. Thus, treasury stocks purchase reduces the assets and total equity of a purchasing company by equal amount.

Restriction on purchase of treasury stock

When treasury stocks are purchased, it reduces the assets and total equity by equal amount of a purchasing company.

As per the common statutory restriction, a limit has been placed on the purchases of treasury stock to extent of the balance lying in the retained earnings account.

The restriction is placed on the purchase of treasury stock to ensure that a company has sufficient funds to pay its creditors. A company should be able to meet its short term and long term financial obligations, after the purchase of treasury stocks.