Final answer:
When a company sells treasury stock for more than its cost, the excess is credited to Paid-in Capital from Treasury Stock, recognizing a capital gain which reflects an increase in shareholder equity independent from company income.
Step-by-step explanation:
When the selling price of treasury stock is higher than its cost, a company records the excess as Paid-in Capital from Treasury Stock. For instance, if Pacific acquired 10,000 shares of treasury stock at $11 each and sells 1,000 at $15 each on March 10, they have a transaction that generates capital gain. The journal entry would debit cash for $15,000 (1,000 shares at $15), credit treasury stock for $11,000 (1,000 shares at $11), and credit the remaining $4,000 to paid-in capital from treasury stock. This capital gain represents an increase in the equity of the shareholders that is apart from the earned income of the company.
Understanding this concept is crucial since capital gains provide a way for investors to realize a return on investment aside from dividends. In practice, this means that the value of the stock or asset grows over time, providing a profit when sold, as seen in the example of a Wal-Mart stock being bought for $45 and sold for $60.