[Commerce Class Notes] on Issue Of Preference Shares Pdf for Exam

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.

    

Redemption of Preference Shares Solved Problems

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.

Issue and Redemption of Preference Shares 

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.  

Accounting for 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.

Preference Shares Formula

The formula for calculating Preference Share capital is as follows:

Accounting Treatment of Redeemable Preference Shares

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.

Redemption of Preference Shares Journal Entries

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.