In 2018, public companies are expected to buy back $1 trillion of their stock. Current accounting rules provide no accounting to shareholders for the profit or loss on this huge expenditure. This is a major failure of the accounting profession.
Accounting for Stock Buybacks
The current accounting rule for stock buybacks is to only record the cost of the buyback as a reduction in the equity section of the balance sheet. There it sits, without any reevaluation to record whether the stock was purchased at a good price. For example, in 2012 IBM bought back its stock at $196 per share, but never wrote down its treasury stock to reflect the decline of its stock price in following years.
It is illogical for third-party, publicly traded stock to be recorded at its fair market value, but publicly traded treasury stock recorded only at cost. Fair market value pricing for both is readily available, and marking treasury stock to market is an important way to evaluate management’s premise that the company’s stock is undervalued. With today’s high price of common stock, the probability is that many companies will buy back their stock at a higher price than will exist in the future. They will continue to do so as long as there is no accounting for the loss to shareholders caused by overpaying for the company’s stock.
Theoretically, buying back a company’s stock will increase the earnings per share and thus the price of the stock. This is based upon two premises: that the earnings in the future will be at least the same as when the buyback occurred, and that the price/earnings ratio will remain the same. There is no reporting about whether these results actually occurred; in fact, there are many instances where stock buybacks did not increase the price of the stock.
Since there is no financial reporting to reflect the movement of the stock price and whether the buyback is a good investment for shareholders compared to alternative use of the funds, shareholders have no basis to evaluate management’s use of corporate cash or borrowed funds to effectuate the buyback. The reality is that corporate boards and management have found that the lack of accounting for the results of stock buybacks allows them to abuse this technique and artificially inflate the short-term price of the company’s stock and stock options.
If the accounting profession fails to address accounting for buybacks, it will be held responsible for the financial crisis that is likely to occur as a result of public companies either using their cash to buy back their stock when other uses were more important—as was recently done by GE—or borrow money to buy back stock and end up not being able to repay the debt, which will certainly happen when a recession occurs.
Do corporate boards and management approve stock buybacks without expecting a financial reward for this investment? Of course they do, but they never inform shareholders of their financial expectations. The lack of accountability for their actions can cost shareholders dearly, through either the lack of long-term investment in the business or the use of after-tax income to repay the debt used to fund the buybacks.
The Clock Is Ticking
This author has contacted FASB on this issue, and learned it will only address the issue if enough CPAs push it to do so. This issue will only get harder to resolve. CPAs would do better to address it now (though it is already late) than to let politicians hold them responsible for not doing so once the financial consequences of this corporate practice finally become apparent.
CPAs who agree with the above should contact FASB and request that it initiate a study on how to account for stock buybacks.