Redemption of Preference Shares

1. Redemption of Preference Shares Redeemable Preference Shares: Equity OR Liability FRS 132 and Co Act 1965

2. Definitions • Financial assets : FRS 132 (11) a) cash b) an equity instrument of another entity c) a contractual rights (i) to receive cash or another financial asset from another entity

3. Definitions • Financial liability : FRS 132 (11) a) contractual obligation: i) to deliver cash or another financial asset to another entity ii) to exchange financial instrument … under condition that are potentially unfavourable

4. Definitions • Equity instrument : FRS 132 (11) … any contract that evidences a residual interest in the assets of an entity after deducting all of its liability A - L = E

5. Definitions • Financial instrument : FRS 132 (11) …any contract that gives rise to financial assetof one entity and… (at the same time) gives rise to … a financial liability or equity instrument of another entity.

6. Presentation of instrument FRS 132 (15) : The issuer…shall classify the instrument …on initial recognition as a financial liability, financial asset or an equity instrument in accordance with the substance of the contractual arrangement and the definitions…

7. More … FRS 132 (35): Interest, dividend, losses and gains related to … financial liability should be reported in the income statement as expense or income. Distribution to holder of …equity instrument should be debited …directly to equity.

8. Preference shares Equity or liability: • obligations to deliver cash or financial assets? Or to exchange? • interest in residual assets? [profit = increase in equity]

9. “Redeemable” Redeem : exchange or buy back issuer has a contractual obligation to redeem : a) fixed / determinable future amount b) at a fixed / determinable future time [known at the point of contract]

10. Redeemable preference shares RM50m 10% RPS of RM1 each and redeemable in 5 years at a premium of RM0.50 each VS RM50m 10% coupon Bond

11. R P S • legal form of equity but are liabilities in substance i – mandatory redemption ii – fixed / determinable future amount iii – fixed /determinable future date iv – put option by holder

12. PS with option to redeem • equity • put option by holder : liability • option by issuer, voluntarily : liability if terms and condition is such that issuer may have no choice but to redeem it at some point in the future e.g. accelerating dividend

13. Conflicts Co Act : 9th Schedule …different classes of shares be disclosed separately as part of the share capital … …dividend is treated as an appropriation of profits, not expense… Sect 166A(6) and notwithstanding Sect 169(14) … true and fair view

14. Consequences : disclosure & treatment of dividend Equity : • disclose under Equity • dividend : directly charged to Equity (deduction to earnings/profits) Liability : • dividend : charged to Income Statement (expense) • disclose under Long-Term Liability (unless redemption is known to be less than one year)

15. Consequences : issue of the shares Equity : Dt Cash Cr Preference Share (R) Cr Share Premium Liability : Dt Cash Cr RPS [par + premium/discount]

16. Bond Price / Value at issue date: PVn = nΣt=1 Int + M . (i + r)n (i + r)n

17. RPS Price / Value at issue date: PVn = nΣt=1 Div + Red . (i + r)n (i + r)n

18. Consequences : dividend payments Equity: Dt Retained Profits Cr. Dividend Payable Dt Dividend Payable Cr. Cash/Bank

19. Consequences : dividend payments Liability: Dt. Dividend Exp Cr. Cash/Bank Cr. RPS OR Dt. Dividend Exp Dt. RPS Cr. Cash/Bank

20. Consequences : on redemption Equity: Dt. PS(R) Dt. Premium on Redemption Cr. Cash / Bank Liability: Dt. RPS Cr. Cash / Bank

21. Consequences : premium on redemption Equity: Dt. Share Premium Cr. Premium on Red. Liability: Dt..Share Premium Cr. Retained Profits