Question

When a company acquires treasury stock, what effect does this transaction have on earnings per share and legal capital, respectively?

	a.	increase, none
	b.	increase, decrease
	c.	decrease, decrease
	d.	decrease, increase

Answer 1

• When a company acquires Treasury stock:

No. of outstanding shares get DECREASED. As the result of this, the earning per share outstanding INCREASES.

For example: Net Income $100000.
Common Stock outstanding before treasury stock purchased = 10000 shares
Earning per share = Net income/No. of shares outstanding = 100000 / 10000 = $10 per share.

Now say if 2000 shares are re acquired as treasury stock, no. of outstanding shares become 8000 shares [10000 – 2000].
Now the new EPS will be $100000 / 8000 shares = $12.5 per share

Hence, EPS Increases when shares are acquired as treasury stock.

Purchase of treasury stock does not result in change of legal capital or issued capital. They do not change. Treasury Stock is shown as a deduction from Contributed capital only.

• Hence, the correct answer is Option ‘a’

Earning per shares INCREASES, and NONE effect on Legal capital.