Question

Should preference shares be disclosed as ‘equity’ or as ‘debt’?

Answer 1

ans)    The preference shares contain an obligation to pay cash to the preference shareholders and they should be classified as a financial liability, disclosed as current / non-current dependant on the contractual terms. The 10% dividends should be recognised as a finance cost in the profit and loss account .

According to International Accounting Standards (IAS) 32 , preference shares can be classified as equity , liabilty or a combination of the two. The entity must classify the financial instrument when initially recognising it based on the substance over form principle  .In general , this principle requires issuers to measure and present the economic impact on the financial instrument and to state its commercial purpose - but it does not oblige them to consider local business laws. This can cause confusion because sometimes local laws call for different classifications than the accounting requirements do.

A preference share that is redeemable only at the holder' s request may be accounted for as DEBT  even though legally it is a share of the issuer. This could be because the substance of the terms and conditions requires the issuer to deliver cash or another financial asset to settle a contractual obligation.

However, in some cases, the instrument' s legal form can supersede the substance over form principle . For example, if a local law, regulation, or the entity' s governing charter gives the issuer of the instrument an unconditional right to avoid redemption - in such a case , the instrument could be classified as EQUITY.