The cost method is one of two ways to record the purchase of treasury stock. The cost method is widely accepted under both US GAAP and IFRS. In fact it is the only method allowed under IFRS. Treasury stock is purchased and recorded at its fair value. Once the treasury stock is re-sold out in the market, the fair value is used as a purchase price to calculate any decreases in retained earnings and increases or decreases in additional paid in capital stemming from the sale of the stock.
Here is an example:
Journal Entry 1: On January 1st Adequate Disclosure, Inc. issues 1,000 shares with a par of $10 to Inadequate Disclosure, Inc. for $20.
- Cash: $20 x 1,000 = $20,000
- Common Stock: $10 par value x 1,000 shares = $10,000
- Additional Paid in Capital (Excess of selling price x Shares): ($20-$10= $10) $10 x 1,000 = $10,000
Journal Entry 2: On January 2nd Adequate Disclosure re-purchases 700 shares for $25.
- Treasury Stock: Fair Value x Shares $25 x 700 = $17,500
- Cash: $25 x 700 = $17,500
Journal Entry 3: On January 3rd Adequate Disclosure sells previously purchased Treasury stock of 500 at a gain for $30.
- Cash: $30 x 500 = $15,000
- Treasury Stock: Fair Value x Shares $25 x 500 = $12,500
- Additional Paid In Capital of Treasury Stock = Excess of purchase price ($30-$25=$5) $5 x 500= $2,500
Journal Entry 4: On January 4th Adequate Disclosure sells the remainder of previously purchased Treasury Stock (200 stocks remaining) for a loss of $15.
- Cash: $15 x 200 = $3,000
- APIC T/S (Additional Paid In Capital from Treasury Stock): Excess of purchase price ($25-$15= $10) = $10 x 200 = $2,000
- Treasury Stock: Fair Value x Shares $25 x 200 = $5,000