Morgantown Merchants is an all-equity firm with positive netincome. Which one of

Question

Morgantown Merchants is an all-equity firm with positive netincome. Which one of the following will result if the firmrepurchases some of its outstanding shares?
a. the price-earnings ratio will decrease b. total equity will increase c. the number of shares outstanding will increase d. the earnings per share will decrease e. total assets will remain constant
a. the price-earnings ratio will decrease b. total equity will increase c. the number of shares outstanding will increase d. the earnings per share will decrease e. total assets will remain constant

Explanation / Answer

When a firm buys its own shares, it is actually creatingTreasury stock. It is treated in either of two ways below. Thus wecan see that Total Assets Remain constant.
There are two acceptable ways to account for treasury stock underGenerally Accepted Accounting Principles (GAAP): the cost methodand the par value method.

The Cost Method. When a company uses the cost method, the purchaseof treasury shares is recorded at cost in a contra-equity accountcalled Treasury Stock. It's shown on the balance sheet at the endof the stockholders' equity section as a deduction.

The Par Value Method. In contrast to the cost method, when acompany uses the par value method there's no Treasury Stock accounton the balance sheet. The cost of the repurchased shares isdeducted from paid-in capital accounts, and the shares are treatedas if they were retired. If the company pays more than the originalissue price for the shares, the excess cost is deducted fromretained earnings. When a firm buys its own shares, it is actually creatingTreasury stock. It is treated in either of two ways below. Thus wecan see that Total Assets Remain constant.

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