presentation of redeemable preference shares in balance sheet

Redemption of Preference Shares: Practical Problems and Solutions

Written by True Tamplin, BSc, CEPF®

Reviewed by subject matter experts.

Updated on April 23, 2023

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Table of Contents

Problem 1: redemption of preference shares at premium.

On 1 July 2000, a limited company issued 10,000 redeemable preference shares valued at $10 per share. The shares were redeemable at a premium of 10%.

Two-fifths of the company's issue was redeemed out of profits on 10 January 2004. On 20 January 2004, the company issued 20,000 equity shares at $10 each at a premium of $4 per share. Out of the proceeds of the issue, the balance of redeemable preference shares was redeemed.

Required: Make journal entries to record these transactions in the company's books.

Journal Entries

Problem 2: Redemption of Shares at Premium, Partly Out of Profits and Partly Out of Fresh Issue

A company issued 50,000 equity shares at $10 per share and 3,000 redemption preference shares at $100 each. All shares were fully called and paid up.

On 31 March 2004, the profit and loss account showed an undistributed profit of $50,000. The general reserve account stood at $120,000.

On 2 April 2004, the directors decided to issue 1,500 6% preference shares at $100 per share for cash. They also redeemed the existing preference shares at $105, utilizing as much profits as required for the purpose.

• Show the journal entries to record these transactions
• Prepare a summarized balance sheet showing the company's position on completion of the redemption

On 31 March 2004, the cash balance amounted to $185,000 and Sundry Creditors stood at $87,000.

Problem 3: Where Minimum Number of Equity Shares Is to Be Issued for Redemptions

The summarized balance sheet of a company is given as follows:

The redeemable preference shares will be redeemed at a premium of 10%.

The company's directors wish that only the minimum number of fresh equity shares of $10 each at a premium of 5% be issued to provide for the redemption of such preference shares, as could not otherwise be redeemed.

Required: Give the journal entries and prepare the balance sheet after redemption.

To calculate the minimum number of fresh shares to be issued, first let the dollar value of shares to be issued equal X.

Alternatively,

Balance Sheet

Redemption of Preference Shares: Practical Problems and Solutions FAQs

What is the redemption of preference shares.

The redemption of preference shares is the process by which a company repurchases its own preferred stock from shareholders.

Is redemption of preference share a debt interest or an equity interest?

They are hybrid securities, which generally combine debt and equity. Depending on their terms, the australian taxation office (ATO) may classify them as a debt interest rather than an equity interest. This may have tax implications for shareholders.

What is the formula for redemption of preference shares?

Price of preference = (total number of redeemable preferred shares / number of preference shares issued) x 100

What is the important point to be noted when preference shares are redeemed?

The cash account should be debited to record redemption of preference shares. If the preference shares are redeemed for $10 per share, a debit entry will be made to the cash account. Likewise, if preference shares are redeemed for Rs 10 per share, a credit entry will be made to the cash account.

What will happen to these shares when the company redeems them?

Upon redemption, the redeemable preference shares are canceled. You should remember that a company’s redemption of the shares eliminates any dividend rights attached to them. An exception to this is where the terms of issue specify otherwise.

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide , a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University , where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon , Nasdaq and Forbes .

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Retractable or Mandatorily Redeemable Shares Issued in a Tax Planning Arrangement

Accounting standards for private enterprises.

In December 2018, the Accounting Standards Board concluded its project to re-examine the special treatment 1 for preferred shares issued in a tax planning arrangement provided by Section 3856, Financial Instruments , by issuing final amendments to paragraph 3856.23. The amendments apply to annual financial statements relating to fiscal years beginning on or after January 1, 2020. Earlier application is permitted.

Prior to the effective date of the amendments, an enterprise issuing preferred shares in a specified tax planning arrangement 2 presents the shares at par, stated or assigned value as a separate line item in the equity section of the balance sheet, with a suitable description indicating that the preferred shares are redeemable at the option of the holder. These preferred shares remain in equity until such a time that redemption is demanded. Upon redemption being demanded, these preferred shares are reclassified to liabilities and measured at the redemption amount with any adjustment recognized in retained earnings.

What are the main changes?

• Control 3 of the enterprise issuing the ROMRS in a tax planning arrangement is retained by the shareholder receiving the shares in the arrangement;
• No consideration is received by the enterprise issuing the ROMRS; or
• Only shares of the enterprise issuing the ROMRS are exchanged; and
• No other written or oral arrangement exists (e.g., a redemption schedule), that gives the holder of the shares the contractual right to require the enterprise to redeem the shares on a fixed or determinable date or within a fixed or determinable period.

If any of the above conditions are not met, the shares are required to be classified as a financial liability, separately presented on the balance sheet and measured at the redemption amount.

As indicated above, ROMRS issued in a tax planning arrangement that meet all three of the above conditions may be presented at par, stated or assigned value. Even when all three criteria above are met, an enterprise may choose to present the ROMRS issued in a tax planning arrangement as a financial liability.

Reclassification of ROMRS issued in a tax planning arrangement classified as equity would be required if an event or transaction occurs that may indicate that any of the three criteria above are no longer met. ROMRS issued in a tax planning arrangement that are initially classified as a liability are not subsequently reclassified.

 What are the potential impacts of the amendments?

For some enterprises, the amendments to paragraph 3856.23 will be negligible or limited to disclosure (e.g., a description of the arrangement that gave rise to the shares). For others, there may be a profound impact on the financial statements.

To demonstrate the impact on an enterprise’s balance sheet of the amendments, consider ROMRS issued in a tax planning arrangement that do not meet the retention of control criteria in amended paragraph 3856.23. Assume that the stated amount of the shares is $10 and that they have a redemption amount of $1,200,000.

As a result of the amendments to paragraph 3856.23, the enterprise’s financial position differs as the ROMRS would now be required to be measured at their redemption amount (i.e., $1,200,000) and presented separately on the balance sheet. Consequently, the financial ratios of the enterprise are impacted including, but not limited to, the enterprise’s current ratio and debt-to-equity ratio. Moreover, any dividends declared on the ROMRS would now be presented as an interest expense in the income statement in accordance with paragraph 3856.15 and not directly in equity. This may impact bonus calculations and profit-sharing arrangements that are based on net income.

The Take-away?

It is important for an enterprise that has previously issued preferred shares in a tax planning arrangement or intends to issue ROMRS in a tax planning arrangement to fully understand the impact of the amendments to paragraph 3856.23. While there are certain transitional provisions available to enterprises that have previously issued preferred shares in a tax planning arrangement, the amendments to paragraph 3856.23 could still impact financial ratios or covenants that are relevant to the users of the financial statements. Financial statement preparers should proactively identify contracts and other relevant agreements that may be impacted by the amendments to paragraph 3856.23 to ensure that there are no unintended consequences as a result of these changes. If there is a significant impact (e.g., anticipated covenant breaches) of the amendments to paragraph 3856.23, financial statement preparers should work diligently with users to mitigate the impact (e.g., amend the covenants).

This article has been prepared for the general information of our clients. Specific professional advice should be obtained prior to the implementation of any suggestion contained in this article. Please note that this publication should not be considered a substitute for personalized tax advice related to your particular situation.

1 To permit equity classification despite meeting the definition of a liability as set out in Financial Statement Concepts, Section 1000. 2 Under Sections 51, 85, 85.1, 86, 87 or 88 of the Income Tax Act (Canada). 3 As set out in Subsidiaries, Section 1591. 4   For purposes of this example the adjustment has been recorded in deficit. Enterprises have an option to present the adjustment in a separate component of equity.

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