Question

Question 1 (Marks: 10)

According to IAS33 – Earnings per share there are two types of shareholder, namely ordinary shareholders and preference shareholders.

Q.1.1 Why do we call them “preference” shares or shareholders? Explain what advantages for the shareholder this implies. (5)

Q.1.2 If an entity has issued cumulative redeemable preference shares to the market, discuss what effects this will have on the liabilities that the company will report in their financial statements. (5)

Answer 1

Answer 1.1

As the name suggest, Preference shareholders are given preference over Equity or common shareholders. During the closure of company, may be due to bankruptcy, preference shareholders are paid before equity shareholders. They carry fixed dividend rate and dividends paid to preference shareholders before common stock dividends are paid out.

Some advantages of holding preference shares are :

1. Fixed Dividend : Preference shares provides provide fixed rate of dividend and are given preferential rights over common shareholders when it comes to sharing profits. Eg: 8% Preference shares
2. Less risky : Preference shares are suitable to the investors who are risk averse as during the winding up or liquidation of company, preference shareholders are paid before equity shareholders.
3. Variety : There are many types of preference shares, some of which are convertible, participative, cumulative. Hence, the shareholder can choose the best suitable for them.
4. Convertible : Convertible preference shareholders can convert their preference shares to equity shares whenever they wish to.

Answer 1.2

As mentioned above, there are varieties of preference shares available.

One of its kind is Cumulative preference shares. Cumulative preference shares give the shareholder a right to dividends that may have been missed in the past. If the dividend were not given out in the past due to insufficient profits, this dividend gets carried forward to next year and hence the shareholders have right to any earnings not received in the past years.

While redeemable preference shares, are the one which are redeemed or repaid after given fixed period of time.

Therefore, cumulative redeemable preference shares are the one which carry the feature of both cumulative and redeemable preference shares.

As said, if company is unable to pay dividends on Cumulative redeemable preference share ( or stock), the amount of that dividend is termed as arrears. Arrears means any payment of past which is due. Therefore :

• the unpaid dividends appears in the Liabilities side, under the 'Current Liabilities' head and sub-head 'Other current liabilities'
• these arrears are also required to be reported in the footnotes of the balance sheet and will often contain an explanation for such arrear

Important point to be noted: since the question is theoretical and carries more marks(in the case of Q 1.2), explain the terms before you arrive to the final direct answer.