CFA Textbook Volume 3, Reading 39, Practice Problem #7. A. The decline in the company’s equity results from a decline in the market value of this company I can understand this is not true when you think of equity as the difference between asset and liability. But doesn’t a decline in the market value of common shares reduce the capital component of equity? I’m kinda confused
I would think, this is NOT a true statement. To clarify your confusion, we are talking of Book Value and Market Value here. Book Value of equity is (Asset - Liab)/no of outstanding shares. Market value is what is quoted for that company’s shares in share market. So, there is no direct affect of changes in Market Value of a share on its Book Value. Having said that, I am not too sure on valuation of Treasury Stocks though. If they are valued at the price they were bought back or are they valued at their fair value (that is current market price)? My guess is at the price they were bought, but I will let some accounting expert clarify this.
Thanks rus1bus. now I can understand that the market value doesn’t correspond to the equity in financial statement in anyway. About the Treasury Stock, I would assume that it would cause a decline in asset (cash payed to repurchase stocks) and shareholder’s equity by the same amount.
christianwu Wrote: ------------------------------------------------------- > Thanks rus1bus. now I can understand that the > market value doesn’t correspond to the equity in > financial statement in anyway. > > About the Treasury Stock, I would assume that it > would cause a decline in asset (cash payed to > repurchase stocks) and shareholder’s equity by the > same amount. depends on what method is used, there is the treasury purchase method and one other, but yes in general the journal entry will be decrease cash and decrease equity