Treasury shares are own shares acquired through a buy back arrangement and held by a company. In India, the Companies Act allows buy back of shares, but does not allow a company to hold those shares. Bought back shares must be cancelled within seven days. Therefore, in India companies cannot hold treasury stock. However, treasury stock may arise in some schemes of amalgamation under a Court order.
Indian GAAP (AS) does not deal with accounting for treasury stock. Therefore, in India, accounting for treasury stocks should be in conformity with the principles and methods stipulated in IFRS.
IFRS does not allow presentation treasury stocks as investments in the balance sheet. They are presented as a deduction from equity. This is an application of the general principle that economic effects of any transaction with equity shareholders should be presented in equity. The principle follows the logic that when a company transact with owners, in effect, owners are transacting between themselves. We may take the example of buy back of shares. Assume that a company has 1,000 shareholders each holding one share. The company decides to buy back 100 shares. On successful completion of the buy back, if the shares are not extinguished, 1,000 shares remain with 900 shareholders. 900 shares are with individual shareholders and 100 shares are held by the company to benefit all the 900 shareholders, who have collectively used their money invested in the company to buy additional 100 shares. Consequently, the amount of equity investment in the company by the 900 shareholders is reduced. If, we assume that the market price represents the fundamental value of each share and the company has bought back the shares at the market price, the valuation of the company is also reduced proportionately. Companies usually buy back their shares at a time when shares are traded in the market at a price lower than the fundamental value. This results in the increase in the fundamental value per share. This is the reason why a buy back decision signals the market that the shares are undervalued.
Profit or loss arises only from transactions with third parties. It cannot arise in transactions between owners. Such transactions result in transfer of wealth from one set of owners to other set of owners. As per IFRS, the gain or loss from the sale of treasury stocks is adjusted in equity directly. It is not routed through profit and loss account.
A company can hold treasury stocks itself or through another entity, which according to accounting rules should be consolidated in presenting the group financial statements. The fundamental principle is that consolidated financial statements should be prepared on the basis that the 'group' is a single entity. Therefore, even if a consolidating entity holds the shares of the parent, those shares are to be accounted for as treasury stocks.
In India treasury stocks might arise in amalgamation. For example, company A holds shares in company B. Thus, company A is one of the shareholders of company B. Company B merges with company A. Consequently, company A issues shares to all the shareholder of company B. However, company A cannot issue shares to itself. There are two alternatives. Company A may cancel the shares that it holds in company B or it may transfer the shares to a special purpose entity (SPE), usually a Trust. If, it transfers the shares to a SPE, it can issue its own shares to that SPE treating it as a shareholder of B. Many companies have adopted the second alternative. The objectives of the SPE created for the purpose are set in a manner that the it has no flexibility in deciding its operations or the policy can be modified by the sponsor (the company A in our example); and the sole beneficiary is the sponsor. The sponsor controls such an SPE. High Courts approve such schemes. IFRS requires the consolidation of entities that are controlled by the reporting entity. Accordingly the SPE is a consolidating SPE and the shares (of the sponsor) held by the it are treasury shares.
In accounting for treasury shares, many companies in India do not comply with the requirements of IFRS, which codifies the well-accepted principle. They recognise the gain from the sale of treasury shares in the profit and loss account. This signals poor corporate governance.
E-mail: asish.bhattacharyya@gmail.com
Affiliation: Director, International Management Institute - Kolkata
