What are Preference Shares?
Preference shares, also known as preferred stock, are a type of stock that companies issue. Under some specific circumstances, the shares will get preferential treatment over ordinary or common shares. These circumstances may include the distribution of dividends or compensation in case the underlying company liquidates.
Preference shares provide additional security for investors. However, they may come with some drawbacks. For example, most preference shares do not include a voting right. Some of these shares may also come with a fixed dividend. Based on the circumstances, it can provide higher or lower returns. Preference shares also come in various types, such as redeemable preference shares.
What are Redeemable Preference Shares?
Redeemable preference shares have similar characteristics as ordinary preference shares. However, they come with a redemption term that allows the issuer to redeem them at a predetermined rate or price range. In other words, the issuing company gets the right to buy back these shares at a specific price at any time. However, these shares will have a redemption period during which this clause will be applicable.
Redeemable shares are more advantageous to the issuer compared to the investors. Therefore, they are less secure for investors compared to irredeemable preference shares or other types. However, investors may get a premium price at redemption. Due to the redemption clause involved, the accounting for redeemable preference shares also differs from other types of preferred shares.
Valuation of Redeemable Preference Shares
Redeemable preference shares can be valued using the same valuation techniques used for valuation of convertible bonds.
What is the accounting for Redeemable Preference Shares?
Before understanding the accounting for redeemable preference shares, it is crucial to know how entities report irredeemable preferred stock. Irredeemable preferred stock is the opposite of redeemable preference shares. On top of that, the accounting for these shares may differ based on which stage of the process. For most of the process, both IFRS and GAAP accounting treatment for redeemable preference shares are similar.
On issuance
Usually, when a company issues irredeemable preferred stocks, the accounting treatment is straightforward. The entity records the cash inflows by recognizing equity in the balance sheet.
Therefore, the accounting treatment for irredeemable preference shares will be as follows.
Dr Cash/Bank
Cr Preference Shares (Equity)
However, redeemable preference shares also include a redemption clause. Although these shares are technically equity, this clause changes them. Therefore, companies that issue redeemable preference shares must record a liability in their balance sheet. This accounting treatment differs from that of irredeemable preference shares, where the company has to record equity.
Therefore, the accounting treatment for redeemable preference shares will be as follows.
Dr Cash/Bank
Cr Redeemable Preference Shares (Liability)
Dividend payments
As mentioned, companies also have to pay dividends on preference shares. When it comes to irredeemable preference stocks, companies must reduce these dividends from their retained earnings. This treatment is because these shares get treated as equity. However, for redeemable preference shares, the same will not apply.
Since companies treat redeemable preference shares as liability, any dividend paid to the shareholders is considered an expense. Therefore, the accounting treatment for redeemable preference shares dividends will be as follows.
Dr Expense
Cr Cash/Bank
On redemption
When companies redeem their preference shares, they will need to pay a predetermined price to the shareholder. Usually, this price will include a premium that requires the issuer to pay more than the share’s face value. On redemption, the accounting entries for redeemable preference shares will be as follows.
Dr Redeemable Preference Shares (Liability)
Dr Premium (Expense)
Cr Cash/Bank
What is the accounting for Irredeemable Preference Shares?
The accounting for irredeemable preference shares is discussed in this article: Preference Shares Accounting Treatment
Conclusion
Preference shares allow shareholders to get a preferred treatment compared to ordinary shareholders. The accounting treatment for preference shares will differ on the type of share issued. For redeemable preference shares, accounting standards require reporting entities to treat them as a liability. This treatment is similar under both IFRS and GAAP standards.
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