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For example, this means that a redeemable preference share, where the holder can request redemption, is accounted for as debt even though legally it may be a share of the issuer.
icaew.com DownloadIn order to determine whether a preference share constitutes a financial liability, equity, or a compound instrument, it is necessary to analyse the terms relating to redemption and the payment of dividends (i.e. the extent to which there is a contractual obligation of the issuer of
The classification of preference shares in the financial statements of the issuer depends on the terms and rights attached to the shares with regards to redemption and dividends. The classification criteria are set out in FRS 102 section 22 – Liabilities and Equity.
To compensate for the loss of voting power, the shares will often have preferred rights over the ordinary shares, such as fixed dividends and/or redemption rights, as well as preference on liquidation.
The treatment of preference shares as debt or equity depends on the rights attached to them. In simple terms: - if the share holder has the right to cash in their preference shares at their discretion or within a fixed period, then you treat as debt. Think bank loan/overdraft from individual.
Preference shares can be classified as equity, liability or combination of the two. As per IAS 32.15, for classification purposes, to consider the substance of the contractual agreement in order to classify the RPS as liability or equity.
For example, if under its terms of issue a preference share is mandatorily redeemable on a certain date, the issuing company has a contractual obligation. The preference share will therefore be a...
When a preferred share is redeemable (or contingently redeemable) at the option of the issuer, permanent equity classification assumes the holder does not control the board of directors (or could not control the board as a result of events outside the issuer’s control, such as a debt default).
Following action is determining whether to consider the preference share as debt or equity. Are the shares redeemable at a fixed date? Are the shares redeemable at the option of the holder? Is the issuer obliged to make payments in the form either of interest or dividends?
The conclusion here is that redeemable preference shares will usually create a contractual obligation for redemption, and would be treated as a financial liability, while irredeemable preference shares (or redeemable at the company's discretion) are equity instruments (but see below in relation to non-discretionary dividend payments creating a ...