Preference shares are shares that represent part of capital issued by a company. The shares thus issued usually carries a definite rate of dividend, which generally is lower than that, is declared on ordinary shares.
Further, the holders of such shares are having a right to receive part of the company’s profit before the payment to ordinary shareholders. If the company fails, preference shareholders have a right to get back the capital repaid.
Under Section 55 of Companies Act 2013, a company can issue preference shares liable to be redeemed at the end of twenty years. A company cannot issue an irredeemable preference share as per the Act. Preference shares are redeemable and the company has to redeem out of profits it earned or out of the proceeds of fresh issue of shares made for such redemption.
The issue of shares for raising capital for a company is of two types. One is equity share capital and the other is preference share capital. The Article of Association of a company empowers the board to issue preference shares, setting certain terms and conditions. The maximum period for which the company can issue the preference should not exceed twenty years. That is such shares must be redeemed within that period.
The holders of the preference share have a preferential right overpayment of dividends and also for repayment of share capital in the event of failure or winding up of the company. A company can issue only redeemable preference shares. It is also mandatory for a company to issue such shares redeemable within twenty years.
The redemption of preference shares implies the repayment to the shareholders either at a fixed date or within a time frame. Preference shares can be redeemed only if it is fully paid-up. The shares are redeemed out of the profits that are available for distribution to its shareholders or from the fresh proceeds issued for funding the redemption of preference shares.
In a financial statement of a company, redeemable preference shares are reported as a liability. The dividend paid on such shares is recorded as an expense in the income statement. In the case of irredeemable preference shares, the company does not have to retrieve and they are like ordinary shares.
So, they are recorded as part of the equity in the financial statement. Any return paid on such shares is treated as a distribution of profits and reported in the statement of changes in equity.
The formula for calculating Preference Share capital is as follows:
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While redeeming the preference shares from the company’s profits, an amount that is equal to the face value of them is transferred to the capital redemption reserve. In order to immobilize profit from being used for any other purpose, the said procedure is necessary.
Only fully paid preference shares can be redeemed. On redemption, we repay the amount to the shareholders.
At the time of maturity of the preference shares, the journal entry passed is as under:
Both the Redeemable preference share capital account with the face value and the premium on redemption account is reduced by debiting the same. Such debited amounts are to be credited to Preference shareholders Account or Preference Share Redemption Account.
The main reason for crediting Preference Shareholders Account is to get sufficient time for arranging cash from different sources.
1. Explain the problems on the redemption of Preference Shares.
Ans. A company repays on the redemption of preference shares to the shareholders to meet its obligation on account of the shares issued to them. As per the Companies Act, 2013, the preference shares issued by the company must be redeemed within the maximum period of twenty years.
One of the methods for the redemption of preference shares is to use the proceeds collected by the issue of fresh shares. That may be either equity or preference shares. When a fresh issue of shares is made at a premium for the redemption of preference shares, a problem arises.
The points to ponder are whether the proceeds of fresh issue of shares will include the amount of securities premium for the redemption of preference shares. Another problem or disadvantage of redemption of preference shares by the issue of fresh equity shares is that it will dilute the future earning of the company. Shareholding in the company is also changed.
2. What do you mean by companies issuing Preference Shares?
Ans. A company can raise funds for its business by various means. As per the provisions of Companies Act, 2013, a company may issue shares, either equity or preference, to raise additional capital for the business. At a time when the company needs funds for business, they may opt for preferred stocks in addition to common stock. The investors also value preference shares for their relative stability and the preferred status for dividends over common shares. Further, preference shares are more stable than common stocks.
A company can get more funds by way of issue of preference shares as some investors may prefer more consistent dividends and stronger bankruptcy protections than common stocks offer. Some companies may prefer to issue such shares because they keep the debt/equity ratio lower than the issuing of bonds. This gives less control to outsiders than the common stockholders.