Treasury shares effectively lower the amount in the stockholders' equity section of a company's balance sheet. They're not recognized in the income statement, either as gains or losses. Treasury stock are shares, formerly issued and outstanding, that the corporation buys back from shareholders. The cost of buying these shares is deducted from the stockholders' equity balance. Although stockholders' equity is reduced, the corporation's earnings per share typically increases depending on the number of shares purchased.
Corporations often buy back some of their own outstanding stock if the board of directors believes the market price is too low. Reacquiring outstanding shares may invoke the iconic supply and demand equation, influencing a stock market price increase as the supply of shares declines. The effect on stockholders' equity, reducing equity, from an accounting perspective, always takes place. If the corporation buys a significant number of shares, the stock price typically increases.
Corporations that decide to repurchase some outstanding shares usually have a large cash balance. Since cash is an "expensive" asset if it isn't "working," by generating earnings from operations or investments, repurchasing its own stock can be a useful corporate option for investing idle cash. The treasury stock accounting entry credits -- or reduces -- the corporate cash balance and debits -- or increases -- the treasury stock account, recording the cost of repurchasing outstanding shares.
Along with the reduction in stockholders' equity, the corporation's assets decline by the amount of cash used to buy back outstanding shares. If the corporation chooses to sell some treasury stock in the future, it will increase its assets, specifically cash, by the amount realized from the sale. The company will also reduce its treasury stock balance by the amount of shares sold times the buyback cost. The excess cash is recorded in "Paid-in Capital from Treasury Stock," or a similarly named account.
Corporations sometimes decide to permanently retire some stock. If they buy back issued and outstanding shares and do not retire them, they earn treasury stock status, reducing stockholders' equity. However, should the company retire shares it buys back from other investors, the stock is no longer categorized as treasury stock. Until the company formally retires the shares, they should be listed as treasury stock, separated from other issued stock and subtracted from the stockholders' equity balance.
Retained earnings, undistributed profits since the company's birth, can also affect stockholders' equity if treasury stock is retired. When a corporation cancels treasury stock, along with being unavailable for resale, its value must be subtracted from the "Paid-in Capital -- Treasury Stock" account, reducing stockholders' equity. If the treasury stock account is insufficient to complete the accounting transaction, the shortfall must be taken from the retained earnings account, further reducing stockholders' equity.