When an investee buys treasury stock and the investor does not sell shares, the investor is a “net purchaser” as its ownership interest in the investee increases. This transaction is effectively an indirect acquisition by the investor and is similar to when an investor acquires shares of the investee directly from other investors. Accordingly, the investor will need to identify any basis differences created as a result of its ownership percentage increase.
One way to determine the basis difference is to consider the investee purchase of treasury stock and the increase in the investor’s ownership percentage as two transactions. Any cash proceeds received from the investee would reduce the investor’s investment balance. Subsequently, the investor will be deemed to have indirectly acquired an additional interest and should determine the applicable basis differences using that incremental cost.
Example EM 5-2 illustrates a scenario when an investee purchases its own shares at a price greater than their carrying amount, and the investor reflects a change in basis resulting from the decrease in the investee’s carrying amount.
EXAMPLE EM 5-2
Investee purchases shares and investor is a net purchaser
Investor owns 40 common shares in Investee representing a 40% ownership interest (a total of 100 shares are outstanding). The carrying value of the investment on Investor’s books is $10 per share, which is also Investee’s book value per share (i.e., no basis differences exist). Investee subsequently purchases 25 shares from third parties at $12 per share in a treasury stock transaction. The price exceeds Investee’s book value per share of $10.
As a result of this transaction, Investor’s ownership interest in Investee has increased from 40% to 53.3% (40 shares/75 shares). Investor, as a result of not selling any of its ownership interest has, in substance, purchased an additional interest in Investee. Investor does not obtain control of Investee.
How should Investor record the transaction?
Investee’s initial net assets of $1,000 were reduced by the $300 paid by Investee to purchase 25 shares from third parties at $12 per share. Accordingly, the Investor’s proportionate interest in the Investee’s net assets is now $373 (53.3% × $700). As Investor’s carrying amount of $400 is unchanged, Investor will need to identify basis differences of $27, which represents the amount by which its carrying amount exceeds the Investee's carrying amount.
This could also be determined by calculating the excess decrease in Investee’s carrying amount attributable to the repurchase of the shares from third parties of $50 ($2 per share ($12 - $10) * 25 shares) multiplied by Investor’s proportionate interest of 53.3%, which results in a difference of $27. The $27 basis difference should be allocated to the newly acquired 13.3% interest in the net assets of the Investee.
Investee would reflect a treasury stock transaction in its stand-alone financials.