Treasury Stock

What Is the Treasury Stock Method?

The treasury stock method is an approach companies use to process the number of new shares that may possibly be made by unexercised in-the-cash warrants and options, where the exercise price is not exactly the current share price. Extra shares got through the treasury stock method factor into the calculation of the diluted earnings per share (EPS). This method expects that the proceeds a company receives from an in-the-cash option exercise are utilized towards repurchasing common shares in the market.

Understanding the Treasury Stock Method

The treasury stock method states that the essential share count utilized in computing a company's earnings for each share (EPS) must be increased because of outstanding in-the-cash options and warrants, which qualifies their holders for purchase common shares at an exercise price that is below the current market price. To consent to generally accepted accounting principles (GAAP), the treasury stock method must be utilized by a company while computing its diluted EPS.

This method expects that options and warrants are exercised toward the beginning of the reporting period, and a company utilizes exercise proceeds to purchase common shares at the average market price during that period. The number of extra shares that must be added back to the fundamental share count is calculated as the difference between the assumed share count from the options and warrants exercise and the share count that might have been purchased on the open market.

Illustration of Treasury Stock Method

Consider a company that reports 100,000 essential shares outstanding, $500,000 in net income for the past year, and 10,000 in-the-cash options and warrants, with an average exercise price of $50. How about we expect that the average market price for the shares in the last year was $100. Utilizing the essential share count of the 100,000 common shares, the company's fundamental EPS is $5 calculated as the net income of $500,000 partitioned by 100,000 shares. However, this number overlooks the way that 10,000 shares can be promptly issued if the in-the-cash options and warrants are exercised.

Applying the treasury stock method, the company would receive $500,000 in exercise proceeds (calculated as 10,000 options and warrants times the average exercise price of $50), which it might use to repurchase 5,000 common shares on the open market at the average stock price of $100.

5,000 extra shares (the difference between 10,000 assumed issued shares, and 5,000 assumed repurchased shares) address the net recently issued shares coming about because of the likely options and warrants exercise.

The diluted share count is 105,000 = 100,000 essential shares + 5,000 extra shares. The diluted EPS is then equivalent to $4.76 = $500,000 net income \u00f7 105,000 diluted shares.

The number of extra shares that must be added back to the essential share count is calculated as the difference between the assumed share count from the options and warrants exercise and the share count that might have been purchased on the open market.

Features

• The treasury stock method registers the number of new shares that may possibly be made by unexercised in-the-cash warrants and options.
• The treasury stock method must be utilized by a company while working out its diluted earnings per share (EPS).
• This method expects that the proceeds a company receives from an in-the-cash option exercise are utilized to repurchase common shares in the market.