Treasury Stock Method

AAA

DEFINITION of 'Treasury Stock Method'

The component of the diluted earnings per share denominator that includes the net of new shares potentially created by unexercised in-the-money warrants and options. This method assumes that the proceeds that a company receives from an in-the-money option exercise are used to repurchase common shares in the market.

In order to comply with generally accepted accounting principles (GAAP), the treasury stock method must be used by a company when computing its diluted earnings per share (EPS).

INVESTOPEDIA EXPLAINS 'Treasury Stock Method'

The net of new shares that are potentially created is calculated by taking the number of shares that the in-the-money options purchase, then subtracting the number of common shares that the company can purchase from the market with the option proceeds. This adds to the total number of shares in the denominator and lowers the EPS number.

For example, assume that a company currently has in-the-money options that cover 10,000 shares with an exercise price of $50. If the current market price is $100, the options are in-the-money and, based on the treasury method, need to be added to the diluted EPS denominator. The proceeds the company will receive will be $500,000 ($50 x 10,000), which allows them to repurchase 5,000 shares on the market ($500,000/$100). Therefore, the net of new shares is 5,000 (10,000 option shares - 5,000 repurchased shares).

RELATED TERMS
  1. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
  2. Generally Accepted Accounting Principles ...

    The common set of accounting principles, standards and procedures ...
  3. Option

    A financial derivative that represents a contract sold by one ...
  4. Diluted Earnings Per Share - Diluted ...

    A performance metric used to gauge the quality of a company's ...
  5. Exercise Price

    The price at which the underlying security can be purchased (call ...
  6. Warrant

    A derivative security that gives the holder the right to purchase ...
Related Articles
  1. The 5 Types Of Earnings Per Share
    Markets

    The 5 Types Of Earnings Per Share

  2. How To Evaluate The Quality Of EPS
    Markets

    How To Evaluate The Quality Of EPS

  3. Getting The Real Earnings
    Options & Futures

    Getting The Real Earnings

  4. The Top Technical Indicators For Options ...
    Options & Futures

    The Top Technical Indicators For Options ...

comments powered by Disqus
Hot Definitions
  1. Days Sales Of Inventory - DSI

    A financial measure of a company's performance that gives investors an idea of how long it takes a company to turn its inventory ...
  2. Accounts Payable - AP

    An accounting entry that represents an entity's obligation to pay off a short-term debt to its creditors. The accounts payable ...
  3. Ratio Analysis

    Quantitative analysis of information contained in a company’s financial statements. Ratio analysis is based on line items ...
  4. Days Payable Outstanding - DPO

    A company's average payable period. Calculated as: ending accounts payable / (cost of sales/number of days).
  5. Net Sales

    The amount of sales generated by a company after the deduction of returns, allowances for damaged or missing goods and any ...
  6. Over The Counter

    A security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, etc. The phrase "over-the-counter" ...
Trading Center