Treasury Stock Transactions—You Can’t Lose!
The following is adapted from an article appearing in Forbes:
The board of HOSPITAL CORP. OF AMERICA authorized the buyback of 12 million of the firm’s own shares at a total cost of $564 million. However, after the stock market crash of 1987, HCA’s shares were trading at only 31 1/8. So, HCA was now out $190.5 million on its investment—right? Common sense would answer yes, but beyond common sense lurks the logic of accounting. According to generally accepted accounting principles, HCA didn’t lose a penny on the buyback. Call it a no risk investment. In this era of stock market volatility, stock buybacks offer firms the opportunity to tell shareholders that they have a terrific investment—without ever having to own up to the bad news if it turns sour. Consider the criticism in the preceding paragraph and evaluate the reasonableness of the accounting for treasury stock transactions.