In the cost method of accounting for treasury stock, how are gains and losses treated?

• A. Gains are recognized as income on the income statement
• B. Losses reduce retained earnings
• C. Gains decrease paid-in capital
• D. Both gains and losses impact assets

Answer: (B)

In the cost method of accounting for treasury stock, the treatment of gains and losses focuses on how these transactions affect shareholders' equity rather than the income statement. When treasury stock is purchased, it is recorded at cost and is reflected as a reduction in total shareholders' equity.

When a company later reissues its treasury stock at a higher price than its cost, it results in a gain. However, under the cost method, these gains are not recognized as income on the income statement. Instead, they are credited to an account within shareholders' equity, typically to additional paid-in capital.

Conversely, if treasury stock is reissued at a price lower than its cost, it leads to a loss. Under this method, the loss does not impact the income statement but is recognized by reducing additional paid-in capital or retained earnings, effectively reflecting a decrease in shareholders' equity.

Thus, losses reducing retained earnings accurately describes the treatment under the cost method, as they adjust the equity section without affecting net income directly. This explains why the selected answer is correct.