FAR · Select balance sheet accounts · 9 practice questions
Treasury Stock Timeline: APIC, Retained Earnings, and Retirement
Below-cost treasury stock reissues use available APIC from treasury stock before reducing retained earnings. Follow Norton's transactions through retirement to see why later APIC credits cannot erase earlier retained earnings debits.
Try one first
Hint
Track the treasury stock reissuances in order and maintain a running balance of additional paid-in capital created specifically from treasury stock transactions.
Answer B. Under the cost method, reissuing treasury stock above cost creates additional paid-in capital from treasury stock transactions, and reissuing below cost first reduces that pool before retained earnings is affected. The March 1 reissue creates $30,000 of APIC (($46 - $40) x 5,000). The July 1 reissue uses $24,000 of that balance (($40 - $34) x 4,000), leaving $6,000. The October 1 reissue needs $8,000 (($40 - $36) x 2,000), so the remaining $6,000 APIC is used first and retained earnings is debited for the excess $2,000.
Why not A: This is tempting because candidates often recall that treasury stock losses bypass the income statement and conclude retained earnings is immediately reduced. However, under GAAP a below-cost reissue first uses APIC from prior treasury stock transactions of the same class before any reduction of retained earnings.
Why not C: This distractor plays on the correct fact that treasury stock transactions bypass the income statement, but it overlooks the threshold rule: if cumulative APIC from treasury stock transactions is insufficient to absorb a below-cost reissue, the excess reduces retained earnings. That threshold is reached on October 1.
Why not D: This choice misapplies sequencing. APIC created by earlier above-cost reissues is accumulated and available to offset later below-cost reissuances of the same class. With $6,000 of APIC remaining before October 1, only the $2,000 excess reduces retained earnings, not the full $8,000.
The timeline
- January 2, Year 1Norton issues 100,000 shares of $1 par common stock for $18 per share.
Each share's original proceeds include $1 of common stock and $17 of APIC-common. These amounts matter when shares are retired.
- Beginning of Year 2APIC from treasury stock transactions has no beginning balance.
Norton uses the cost method. Below, treasury APIC means APIC from treasury stock transactions. No other equity transactions occur.
- Year 2, repurchaseNorton repurchases 20,000 shares for $26 per share.
Debit Treasury Stock $520,000. Treasury APIC remains $0. Retained earnings is unchanged.
- Year 2, first reissueNorton reissues 8,000 treasury shares for $24 per share.
The deficit is 8,000 x $2 = $16,000. With no treasury APIC available, debit retained earnings $16,000. Treasury Stock remaining: $312,000.
- Year 2, second reissueNorton reissues 6,000 treasury shares for $29 per share.
The excess is 6,000 x $3 = $18,000. Credit treasury APIC $18,000. Treasury Stock remaining: $156,000. The earlier retained earnings debit remains.
- Year 2, retirementNorton retires the remaining 6,000 treasury shares.
Debit Common Stock $6,000 and APIC-common $102,000. Cost exceeds original proceeds by $48,000. Debit treasury APIC $18,000 and retained earnings $30,000. Credit Treasury Stock $156,000.
- End of Year 2Check the ending balances and cumulative retained earnings effect.
Treasury Stock: $0. Treasury APIC: $0. Retained earnings decreased $46,000: $16,000 on the first reissue plus $30,000 on retirement.
Key points
- Remember: use the treasury APIC available at each event; later credits do not restore retained earnings.
- For reissues, compare proceeds with repurchase cost, not par or the original issue price.
- APIC from common stock is not interchangeable with APIC from treasury stock.
- Treasury stock is contra-equity. These transactions create no income statement gains or losses.
How the exam traps you
- Charge the entire below-cost reissue deficit to retained earnings. Use the available credit balance in APIC from treasury stock first.
- Compare the reissue price with the original issue price. Compare reissue price with treasury cost. Original issue proceeds matter when the shares are retired.
- Net all reissue price differences at year-end. Record each event in order. Later APIC credits cannot reverse an earlier retained earnings debit.
Question 2
| Account | Amount |
|---|---|
| Common stock, $1 par | $500,000 |
| Additional paid-in capital from common stock | $3,500,000 |
| Treasury stock (60,000 common shares at cost) | $840,000 |
| Additional paid-in capital from treasury stock transactions | $20,000 |
| Retained earnings | $4,200,000 |
| # | Transaction |
|---|---|
| 1 | Reissued 25,000 treasury shares for $12 per share |
| 2 | Reissued 15,000 treasury shares for $17 per share |
| 3 | Issued 100,000 new common shares for $16 per share; paid $80,000 direct incremental issuance costs |
| 4 | Declared and distributed a 10% common stock dividend when market price was $18 per share |
Hint
Track APIC from common stock and APIC from treasury stock separately, and be careful about the order in which treasury stock reissuances affect APIC and retained earnings.
Answer A. Compute APIC components sequentially. The 25,000 treasury shares reissued at $12 (cost $14) create a $50,000 shortfall that uses the $20,000 beginning APIC from treasury and charges the remaining $30,000 to retained earnings; the 15,000 reissued at $17 creates $45,000 of new APIC from treasury. The new issuance adds (16−1)*100,000 − 80,000 = $1,420,000 to APIC, and the 10% stock dividend on 580,000 outstanding shares creates (18−1)*58,000 = $986,000 of APIC, so total APIC = 3,500,000 + 1,420,000 + 986,000 + 45,000 = 5,951,000.
Why not B: This comes from netting the two treasury reissuances (20,000 − 50,000 + 45,000 = 15,000 APIC from treasury) instead of applying the below-cost reissue in sequence; the correct chronological treatment uses beginning APIC first and then retained earnings for the excess.
Why not C: This reflects forgetting to subtract the $80,000 of direct issuance costs from the proceeds of the new issuance; issuance costs reduce APIC and therefore lower total APIC by $80,000.
Why not D: This results from charging the entire $50,000 treasury shortfall to retained earnings while leaving the beginning $20,000 APIC from treasury intact and then adding the $45,000 excess, incorrect because existing APIC from treasury must be used first.
Question 3
Hint
Compute cost of the shares reissued vs. proceeds, then remember the order: APIC, Treasury Stock absorbs deficits first; any remaining shortfall reduces retained earnings under the cost method.
Answer B. Cost of the reissued shares = 2,000 × $20 = $40,000; proceeds = 2,000 × $15 = $30,000, producing a $10,000 deficit. Under the cost method, APIC, Treasury Stock is debited to the extent of its $6,000 credit balance; the remaining $4,000 deficit reduces retained earnings. Treasury stock is credited for $40,000 to remove the cost of the shares reissued.
Why not A: Plausible if a student simply subtracts proceeds from cost and assumes APIC must absorb the full $10,000 shortfall; it's wrong because APIC only had $6,000 available, so the excess $4,000 must reduce retained earnings.
Why not C: This distractor confuses below-cost reissuances with above-cost reissuances; APIC would be credited only when proceeds exceed cost, not when proceeds are below cost.
Why not D: Attractive if one knows retained earnings can absorb deficits but forgets the hierarchy; under the cost method APIC, Treasury Stock must absorb deficits first before any remaining shortfall reduces retained earnings.
Question 4
Hint
Track the APIC balance created and used by the earlier treasury stock reissuances before deciding whether any remaining deficit reaches retained earnings.
Answer C. Under the cost method, the first reissuance creates $18,000 of APIC from treasury stock transactions (6,000 × $3). The second reissuance below cost reduces that balance by $8,000, leaving $10,000. The December 15 reissuance is $15,000 below cost (3,000 × $5), so Arbor must first debit the remaining $10,000 APIC from treasury stock transactions and then debit retained earnings for the remaining $5,000. Treasury stock transactions do not create income statement gains or losses.
Why not A: This option tempts candidates who think all APIC accounts are interchangeable. GAAP allows only APIC arising from prior treasury stock transactions to absorb reissuance deficits; other contributed capital accounts (such as APIC-common stock) are not used for this purpose, so the remaining deficit must reduce retained earnings.
Why not B: This distractor exploits the common memory that deficits on treasury stock can reduce retained earnings. It is wrong because retained earnings is reduced only after any APIC created by prior treasury stock reissuances has been exhausted; $10,000 of that APIC remains here.
Why not D: This distractor appeals to the intuitive sense of an economic loss, but treasury stock transactions are transactions with owners and are recorded in equity. They do not produce gains or losses in the income statement, so no loss is recognized.
Question 5
Hint
Update the treasury-stock APIC balance after the above-cost reissue before you analyze the retirement of the remaining shares.
Answer C. The original issue amount for 4,000 shares equals $56,000 (4,000 × $2 par = $8,000 plus 4,000 × ($14 − $2) = $48,000 APIC‑common). The retirement removes treasury stock at its cost of $76,000 (4,000 × $19), producing an excess of $20,000. APIC from treasury stock transactions had a $10,000 credit at January 1 and increased by $6,000 from the 2,000‑share reissue above cost (2,000 × ($22 − $19)), so $16,000 of APIC from treasury is available. Apply that $16,000 first, and charge the remaining $4,000 to retained earnings.
Why not A: Candidates who recall that excess retirement cost can reduce retained earnings may jump to this, but they overlook the required ordering: available credits in APIC from treasury stock transactions must be used before retained earnings is reduced.
Why not B: This seems plausible if a candidate forgets to update APIC from treasury stock transactions for the $6,000 credit created by the 2,000‑share reissue above cost. The available APIC is $16,000, not $10,000, so only $4,000 of the excess hits retained earnings.
Why not D: APIC‑common is removed only to the extent of the original issuance amounts attributable to the retired shares; the excess of reacquisition cost over original issue is not charged to APIC‑common but to APIC from treasury stock transactions first and then to retained earnings if needed.
Question 6
Hint
Separate the accounting for each step under the cost method: repurchase, reissue below cost, and retirement. Pay attention to whether any APIC from treasury stock exists before deciding where a shortfall goes.
Answer A. Under the cost method, the repurchase creates treasury stock at cost and does not immediately change contributed capital or retained earnings. Reissuing 6,000 shares at $16 when cost was $18 produces a $12,000 shortfall that, with no APIC-from-treasury available, is charged to retained earnings. Retirement of the remaining 9,000 shares removes $9,000 of common stock (par) and $117,000 of original APIC (total $126,000) from contributed capital; because the treasury cost retired was $162,000, the $36,000 excess also reduces retained earnings. Total effects: contributed capital down $126,000 and retained earnings down $48,000.
Why not B: This attracts candidates who recall APIC must be reduced on retirement but forget that par value (common stock) is also removed from contributed capital. Retirement removes both the $9,000 common stock (par) and the $117,000 APIC, so contributed capital falls $126,000, not $117,000.
Why not C: This correctly captures the retirement effect on contributed capital but overlooks the earlier below-cost reissuance. The $12,000 deficiency on the 6,000-share reissue (no APIC-from-treasury available) also reduces retained earnings, making the total retained earnings reduction $48,000, not $36,000.
Why not D: This reflects a misapplication of the cost method by treating the treasury stock carrying amount as if it directly reverses against contributed capital. In reality, retirement removes the original issuance amounts from contributed capital and charges any excess of reacquisition cost over those original amounts to retained earnings; the earlier below-cost reissue also reduced retained earnings, so retained earnings cannot remain unchanged.
Question 7
Hint
Compute proceeds versus cost for the reissued shares to find the total deficit, then apply the rule: use paid-in capital from prior treasury transactions first, then retained earnings for any remaining deficit.
Answer C. Reissuing 2,000 shares at $15 produces proceeds of $30,000 while the cost basis is $40,000, creating a $10,000 deficit. Under the cost method, the deficit is first absorbed by paid-in capital, treasury (the $4,000 created on March 1), reducing it to zero; the remaining $6,000 is charged to retained earnings.
Why not A: Incorrect: this treats the entire $10,000 shortfall as hitting retained earnings. GAAP requires using any paid-in capital from prior treasury transactions first, so $4,000 of the deficit is absorbed by paid-in capital before retained earnings are reduced.
Why not B: Incorrect: this assumes paid-in capital - treasury can cover the full $10,000 deficit. Only $4,000 of paid-in capital exists from the March 1 reissuance, so the remaining $6,000 must reduce retained earnings.
Why not D: Incorrect: this misallocates the $10,000 deficit. The available paid-in capital is $4,000 (used first) and the remaining $6,000, not $4,000, reduces retained earnings.
Question 8
Hint
Compute the credit created by the earlier above-cost reissuance before deciding whether retained earnings is affected on the later below-cost reissuance.
Answer A. Under the cost method, the earlier reissuance above cost created APIC from treasury stock of 4,000 × ($21 − $18) = $12,000. The later reissuance is below cost by 5,000 × ($18 − $15) = $15,000; that deficiency is charged first against the APIC from treasury stock ($12,000) and the remaining $3,000 reduces retained earnings.
Why not B: This reflects correctly computing the $15,000 shortfall on the below-cost reissuance but ignores the limit on APIC from treasury stock. Only $12,000 of APIC is available from the prior above-cost reissuance, so the remaining $3,000 must reduce retained earnings.
Why not C: Candidates who select this option forget the required ordering. Retained earnings is not reduced until any APIC from treasury stock created by prior transactions has been exhausted.
Why not D: This confuses the source-specific APIC account. The offset for treasury-stock reissuances must be APIC arising from prior treasury stock transactions, not the general APIC from original stock issuances.
Question 9
Hint
Track the treasury stock reissuances in order under the cost method, and remember which equity account absorbs a below-cost reissuance before retained earnings is touched.
Answer B. Under the cost method, the 4,000-share reissuance above cost creates a $12,000 credit to additional paid-in capital from treasury stock transactions, increasing that account from $9,000 to $21,000. The 5,000-share reissuance below cost creates a $25,000 shortfall, which is charged first against the existing $21,000 balance in that account, with the remaining $4,000 reducing retained earnings. Direct share issuance costs are not expensed; they reduce the paid-in capital from the related stock issuance.
Why not A: This is tempting because candidates often remember that a below-cost treasury stock reissuance can reduce retained earnings. However, retained earnings is reduced only after any existing balance in additional paid-in capital from treasury stock transactions has been exhausted. Here, $21,000 of the $25,000 shortfall is absorbed there first, so retained earnings falls by only $4,000.
Why not C: This distractor is attractive if the candidate stops after the above-cost reissuance and forgets to apply the later below-cost reissuance. The $21,000 balance does arise after transaction 2, but transaction 3 uses all of it and then reduces retained earnings by $4,000. Also, direct stock issuance costs are recorded as a reduction of equity, not as an expense.
Why not D: This choice reflects multiple realistic shortcuts: treating only the current-year $12,000 gain on one reissuance as available to offset the later shortfall, and assuming issuance costs are somehow ignored once gross proceeds are recorded. The prior $9,000 credit balance also must be used before retained earnings, so retained earnings decreases by $4,000, not $13,000. The $60,000 issuance cost reduces paid-in capital from the related issuance.
Common questions
When do treasury stock reissues reduce retained earnings?
A below-cost reissue reduces retained earnings only for the deficit exceeding available APIC from prior treasury stock transactions. Use the balance available immediately before that reissue.
Can a later treasury stock reissue restore retained earnings?
No. An above-cost reissue credits APIC from treasury stock, even if an earlier below-cost reissue reduced retained earnings.
How do you record treasury stock retirement under the cost method?
Remove common stock at par and the original APIC tied to the retired shares. In this sequence, cost above original issue proceeds uses available treasury APIC first, then retained earnings.
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