If a corporation repurchases 500 shares of its previously-issued common stock then retires these shares, which of the following is true?

Question

Quizplus · Accepted Answer

When a corporation repurchases its own stock, these shares are referred to as treasury shares. If the corporation later decides to retire the repurchased shares, it means that these shares are permanently removed from circulation and cannot be reissued. As a result, the corporation must adjust its financial statements to reflect this change.
The retirement of the shares reduces the number of outstanding shares and typically involves the following accounting entries:
1. The common stock (or capital stock) account is decreased by the par value (or stated value) of the retired shares. This reduction reflects the decrease in the total number of shares that the corporation has issued.
2. If the shares were originally issued at a price above their par value, the excess amount (additional paid-in capital or capital in excess of par value) related to the retired shares is also decreased.
3. Any remaining difference between the repurchase price and the combined amount of the reduction in common stock and additional paid-in capital accounts is adjusted in the retained earnings account. This is because the repurchase of shares at a price different from the original issue price does not result in a gain or loss that is reported on the income statement; rather, it is a transaction with shareholders that affects equity.
Therefore, the correct answer is (d) because the common stock and paid-in capital accounts must be adjusted to remove the effects of the original issuance of the now-retired shares. The other options are incorrect for the following reasons:
a. A new class of stock does not need to be issued in place of the retired shares. The corporation can simply reduce the number of shares outstanding without replacing them.
b. Approval from the state is not necessarily required for the retirement of shares. This depends on the corporation's bylaws and the laws of the state in which it is incorporated.
c. A gain or loss is not recorded on the income statement for the retirement of treasury shares. Any difference between the repurchase price and the original issue price is accounted for in equity, not as a gain or loss on the income statement.

If a Corporation Repurchases 500 Shares of Its Previously-Issued Common