Question

Cumnor Hill Ltd issues 1 million redeemable preference shares of $2.00 each on 1st July 2019. The shares offer a rate of return of 7 per cent per annum. The shares are redeemed at the option of the shareholders on 30th June 2021.

Required:

a) Would you classify these preference shares as debt or as equity? Why?

b) Provide the journal entries to account for the issue and subsequent redemption of the shares, assuming that the issue was by a private placement and that the shares are redeemed out of profits.

c) What effect does the redemption of the preference shares have on the total share capital once the journal entries are completed.

Answer 1

a)

Preference shares are always classified as equity and not as debt. They appear on the equity portion of the balance sheet. This is because preference shares are 2nd last in the hierarchy of payment of nominal capital in case the company is wound up.

b)

For Issue:

Cash a/c - Dr. 2,000,000

To Vendor a/c 2,000,000

Vendor a/c - Dr. 2,000,000

To Preference Share Capital a/c 2,000,000

For Redemption:

Preference Share Capital a/c - Dr. 2,000,000

To Preference Shareholders a/c 2,000,000

Preference Share Capital a/c - Dr.    2,000,000

To Cash a/c 2,000,000

c)

The total share capital of the company falls because of reduction in the amount of preference share capital in the equity of the company.