Question

Explain whether a 5% non-cumulative, non-redeemable preference share is similar to an ordinary share or a financial liability.

Answer 1

Before going to discuss about the above concept, it is better to know something about Preference and Ordinary Shares.

Prefernce share:

The preference share holders generally got the fixed percentage of dividend, whatever may be the companies financial positions. It is neither a common stock nor a bond, but a hybrid of both. Like common stock, it brings capital into the company that issues it, instead of more debt. Like a bond, it pays a fixed income that is generally competitive with bond interest when it is first issued.

At the time of dividend payment and liquadation, the priority will be given for the repayment to prefernce shrareholders. After the payment to the prefernce sharehoders, if the any amount available, that will be distributed among the Ordinary shareholders.

Cumulative and Non-Cumulative Prefernce share:

If the shares are cumulative preference shares, the dividends are accumulated and therefore paid before anything paid to ordinary shareholders. Even in the event of liquidation, accumulated preference dividend and preference share capital will be redeemed prior to any payment to ordinary shareholders. Whereas, for non-cumulative preference shares, if company does not pay dividend in current year, claim of preference shareholder is lost to that extent.

Redeemable and Non-Redeemable prefernce shares:

Redeemable preference share is very commonly seen preference share which has a maturity date on which date the company will repay the capital amount. Non-Redeemable preference shares are little different from other types of preference shares. It does not have any maturity date which makes this instrument very similar to Ordinary except that the dividend of these shares is fixed and they enjoy priority in payment of both dividend and capital over the Ordinary shares.

Ordinary Share:

This is also called as the Equity share. This type of shareholders are generally called as real owners of the company. The Equity shareholders generally will got the Voting power, which is not enjoyable by prefernce shareholders. The percentage of dividend to the ordinary shareholders will be changed based on the profit of the business. That is, if the profit margin increase in any academic year, the percentage of dividend also increase, and profit margin decrease the percentage of dividend also decreased. After repayment to the preference holders, the dividend and capital will be paid to equity shareholders.

So, non-cumulative, non-redeemable preference share is similar to an ordinary share or a financial liability in some aspect and not similar in another aspect.

Similar:

Non-cumulative, Non-redeemable preference share and ordinary share are similar in,that is the principal amount will not be paid untill the company liquidation.

In any year the above preference shareholder not receive the dividend it can not be cumulative to next upcoming years like equity share.

Not similar:

Non-cumulative, Non-redeemable preference share holders will be get the fixed percentage of dividend, where as the equity holders percentage of dividend will be varied based on the profit.