NAFTrack Accounting Practice Test

What is the effect of treasury stock on equity?

Increases total equity Has no effect on equity Reduces total stockholders' equity Converts to debt

Correct Answer:

Reduces total stockholders' equity

Explanation:

When a company buys back its own shares, those shares become treasury stock. This is recorded as a deduction from shareholders’ equity, a contra-equity account. The cash paid to repurchase reduces assets, and the corresponding deduction reduces total stockholders’ equity by the same amount, so overall equity decreases. Treasury stock is not an asset, and it does not create debt, so it does not increase or leave equity unchanged or turn into debt. The key idea is that holding treasury stock lowers the total equity.

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