Preference shares, also known as preferred stock, are a unique type of equity that companies can issue to raise capital. These shares come with preferential rights over common shares, particularly regarding dividend payments and claims on assets in the event of liquidation. Accounting for preference shares can be intricate due to these distinct features. This tutorial aims to provide a comprehensive guide to accounting for preference shares, including journal entries and financial statements.
Types of Preference Shares
Before diving into accounting specifics, it’s crucial to understand the different types of preference shares:
- Cumulative Preference Shares: These shares accumulate unpaid dividends, which must be paid out before any dividends on common shares.
- Non-Cumulative Preference Shares: These shares do not accumulate unpaid dividends. If the company skips a dividend payment, shareholders cannot claim it in the future.
- Convertible Preference Shares: These shares can be converted into a specified number of common shares.
- Redeemable Preference Shares: The company can buy back these shares at a predetermined date or price.
- Participating Preference Shares: These shares allow shareholders to receive additional dividends if the company performs well.
Issuance of Preference Shares
When a company issues preference shares, it needs to record the transaction in its financial statements. Let’s assume ABC Ltd issues 10,000 cumulative preference shares with a par value of $10 each at $12 per share.
Journal Entry for Issuance:
Date: 01/01/2024
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Account Debit Credit
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Cash $120,000
Share Capital - Preference Shares $100,000
Share Premium - Preference Shares $20,000
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(Being issuance of 10,000 preference shares at $12 each)Dividend Payments
Preference shares often come with fixed dividend rates. Assume ABC Ltd declares a 5% dividend on its preference shares.
Journal Entry for Dividend Declaration:
Date: 31/12/2024
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Account Debit Credit
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Retained Earnings $5,000
Dividend Payable - Preference Shares $5,000
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(Being declaration of 5% dividend on 10,000 preference shares)Journal Entry for Dividend Payment:
Date: 31/12/2024
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Account Debit Credit
---------------------------------------------------------
Dividend Payable - Pref Shares $5,000
Cash $5,000
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(Being payment of declared dividend on preference shares)Accounting for Unpaid Cumulative Dividends
If ABC Ltd cannot pay the declared dividend due to insufficient profits, the unpaid dividends accumulate.
Journal Entry for Accrued Dividends:
Date: 31/12/2024
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Account Debit Credit
---------------------------------------------------------
Retained Earnings $5,000
Accrued Dividends - Preference Shares $5,000
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(Being accrual of unpaid dividend on cumulative preference shares)Redemption of Preference Shares
If the preference shares are redeemable, ABC Ltd must account for their redemption. Assume the company redeems 5,000 shares at $11 each.
Journal Entry for Redemption:
Date: 31/12/2025
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Account Debit Credit
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Share Capital - Pref Shares $50,000
Share Premium - Pref Shares $5,000
Cash $55,000
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(Being redemption of 5,000 preference shares at $11 each)Conversion of Preference Shares
For convertible preference shares, ABC Ltd might convert 2,000 preference shares into common shares.
Journal Entry for Conversion:
Date: 31/12/2025
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Account Debit Credit
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Share Capital - Pref Shares $20,000
Share Premium - Pref Shares $2,000
Share Capital - Common Shares $22,000
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(Being conversion of 2,000 preference shares into common shares)Financial Statements Presentation
The impact of preference shares on financial statements is significant. Let’s illustrate with simplified financial statements for ABC Ltd.
Balance Sheet
ABC Ltd
Balance Sheet as at 31/12/2025
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Assets
---------------------------------------------------------
Cash $60,000
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Total Assets $60,000
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Equity and Liabilities
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Equity:
Share Capital - Common Shares $120,000
Share Capital - Preference Shares $50,000
Share Premium - Preference Shares $3,000
Retained Earnings $12,000
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Total Equity $185,000
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Liabilities:
Accrued Dividends - Preference Shares $5,000
Dividend Payable - Preference Shares $10,000
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Total Liabilities $15,000
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Total Equity and Liabilities $200,000
---------------------------------------------------------Income Statement
ABC Ltd
Income Statement for the year ended 31/12/2025
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Revenue $100,000
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Expenses
Operating Expenses $80,000
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Net Income $20,000
---------------------------------------------------------Participating Preference Shares
If ABC Ltd issues participating preference shares, these shareholders may receive additional dividends. Assume the company declares an extra $2,000 dividend for participating shareholders.
Journal Entry for Additional Dividend:
Date: 31/12/2025
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Account Debit Credit
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Retained Earnings $2,000
Dividend Payable - Preference Shares $2,000
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(Being declaration of additional dividend for participating preference shares)Summary
Accounting for preference shares involves several steps, from issuance and dividend payments to redemptions and conversions. Each transaction has specific journal entries that impact the financial statements. By understanding and correctly applying these entries, accountants can ensure accurate and transparent reporting.
As you continue to navigate the world of accounting for preference shares, remember that each entry tells a part of the company’s financial story. Accuracy and attention to detail are paramount. Embrace these challenges with confidence, knowing that mastering these concepts enhances your financial acumen and contributes to the integrity of financial reporting.
Comprehensive Example: ABC Ltd’s Preference Shares
Let’s consolidate all our learning into a comprehensive example for ABC Ltd over three years, covering issuance, dividends, unpaid cumulative dividends, redemption, and conversion.
Year 1: Issuance and Dividend Declaration
Issuance:
Date: 01/01/2024
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Account Debit Credit
---------------------------------------------------------
Cash $120,000
Share Capital - Preference Shares $100,000
Share Premium - Preference Shares $20,000
---------------------------------------------------------Dividend Declaration:
Date: 31/12/2024
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Account Debit Credit
---------------------------------------------------------
Retained Earnings $5,000
Dividend Payable - Preference Shares $5,000
---------------------------------------------------------Unpaid Dividend Accrual:
Date: 31/12/2024
---------------------------------------------------------
Account Debit Credit
---------------------------------------------------------
Retained Earnings $5,000
Accrued Dividends - Preference Shares $5,000
---------------------------------------------------------Year 2: Payment of Dividends and Redemption
Payment of Previous Year’s Dividend:
Date: 31/01/2025
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Account Debit Credit
---------------------------------------------------------
Dividend Payable - Pref Shares $5,000
Cash $5,000
---------------------------------------------------------Current Year Dividend Declaration:
Date: 31/12/2025
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Account Debit Credit
---------------------------------------------------------
Retained Earnings $5,000
Dividend Payable - Preference Shares $5,000
---------------------------------------------------------Redemption of Preference Shares:
Date: 31/12/2025
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Account Debit Credit
---------------------------------------------------------
Share Capital - Pref Shares $50,000
Share Premium - Pref Shares $5,000
Cash $55,000
---------------------------------------------------------Year 3: Conversion and Additional Dividends
Conversion of Preference Shares:
Date: 31/12/2026
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Account Debit Credit
---------------------------------------------------------
Share Capital - Pref Shares $20,000
Share Premium - Pref Shares $2,000
Share Capital - Common Shares $22,000
---------------------------------------------------------Additional Dividend Declaration:
Date: 31/12/2026
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Account Debit Credit
---------------------------------------------------------
Retained Earnings $2,000
Dividend Payable - Preference Shares $2,000
---------------------------------------------------------Final Financial Statements
Let’s compile the final financial statements for ABC Ltd at the end of 2026, considering all transactions over the three years.
Balance Sheet as at 31/12/2026
ABC Ltd
Balance Sheet as at 31/12/2026
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Assets
---------------------------------------------------------
Cash $100,000
---------------------------------------------------------
Total Assets $100,000
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Equity and Liabilities
---------------------------------------------------------
Equity:
Share Capital - Common Shares $142,000
Share Capital - Preference Shares $30,000
Share Premium - Preference Shares $3,000
Retained Earnings $24,000
---------------------------------------------------------
Total Equity $199,000
---------------------------------------------------------
Liabilities:
Accrued Dividends - Preference Shares $5,000
Dividend Payable - Preference Shares $7,000
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Total Liabilities $12,000
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Total Equity and Liabilities $211,000
---------------------------------------------------------Income Statement for the year ended 31/12/2026
ABC Ltd
Income Statement for the year ended 31/12/2026
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Revenue $150,000
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Expenses
Operating Expenses $100,000
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Net Income $50,000
---------------------------------------------------------Conclusion
Accounting for preference shares requires a thorough understanding of their unique characteristics and the various transactions associated with them. By mastering the journal entries for issuance, dividends, unpaid cumulative dividends, redemption, and conversion, accountants can ensure accurate and transparent financial reporting. This comprehensive tutorial, with detailed examples and journal entries, serves as a valuable resource for anyone looking to deepen their knowledge of preference shares in accounting.
Embrace these accounting challenges with confidence and precision, knowing that each step you take contributes to the clarity and integrity of your financial statements.