What is the effect of a treasury stock purchase on stockholders' equity and how is it recorded?

• A. Increases common stock; recorded as a credit to Treasury Stock
• B. Increases total stockholders' equity; recorded as a credit to Treasury Stock and a debit to Cash
• C. Reduces total stockholders' equity; recorded as a debit to Treasury Stock (contra-equity) and a credit to Cash
• D. Does not affect stockholders' equity; recorded as a debit to Cash

Answer: (C)

When a company buys back its own shares, those shares become treasury stock, a contra-equity account. This reduces the overall stockholders’ equity because part of the equity is tied up in shares the company holds rather than outstanding to investors.

The purchase uses cash, so the entry reflects an outflow of assets and an increase in the contra-equity balance. You debit Treasury Stock for the cost of the shares (increases the contra-equity balance, which lowers total equity) and you credit Cash for the same amount (assets decrease). Net effect: total stockholders’ equity decreases by the cost of the treasury shares.

That’s why the best description is a reduction in stockholders’ equity recorded as a debit to Treasury Stock and a credit to Cash. It doesn’t increase equity, and it doesn’t involve debiting Cash or crediting Treasury Stock.