ACCA Advanced Financial Management (AFM) Practice Exam

How is the income received by shareholders from stock repurchases typically categorized?

1. As dividends

2. As income

3. As capital gains

4. As other comprehensive income

The correct answer is: As capital gains

Income received by shareholders from stock repurchases is typically categorized as capital gains. When a company repurchases its own shares, it essentially reduces the number of shares outstanding in the market. This can lead to an increase in the value of the remaining shares, as the earnings are now distributed among fewer shares. When shareholders sell their shares back to the company, they are effectively realizing a gain based on the difference between the purchase price and the price they received for their shares. This increase in value reflects a capital gain, which is considered a profit from the sale of an asset, in this case, the shares themselves. Thus, the correct classification of income in this scenario is as capital gains. Dividends are distributions of earnings to shareholders, whereas stock repurchase income typically does not involve retaining earnings but rather focuses on the transaction related to the buyback itself. Other comprehensive income involves certain types of income that bypass the standard income statement, which does not apply in this context. Each of these considerations helps clarify why capital gains is the most appropriate categorization for income resulting from stock repurchases.