Preference Shares Introduction
Preference shares are shares that represent part of capital issued by a company. The shares thus issued usually carries a definite rate of dividend, which generally is lower than that, is declared on ordinary shares.
Further, the holders of such shares are having a right to receive part of the company’s profit before the payment to ordinary shareholders. If the company fails, preference shareholders have a right to get back the capital repaid.
Redemption of Preference Shares Solved Problems
Under Section 55 of Companies Act 2013, a company can issue preference shares liable to be redeemed at the end of twenty years. A company cannot issue an irredeemable preference share as per the Act. Preference shares are redeemable and the company has to redeem out of profits it earned or out of the proceeds of fresh issue of shares made for such redemption.
Issue and Redemption of Preference Shares
The issue of shares for raising capital for a company is of two types. One is equity share capital and the other is preference share capital. The Article of Association of a company empowers the board to issue preference shares, setting certain terms and conditions. The maximum period for which the company can issue the preference should not exceed twenty years. That is such shares must be redeemed within that period.
The holders of the preference share have a preferential right overpayment of dividends and also for repayment of share capital in the event of failure or winding up of the company. A company can issue only redeemable preference shares. It is also mandatory for a company to issue such shares redeemable within twenty years.
The redemption of preference shares implies the repayment to the shareholders either at a fixed date or within a time frame. Preference shares can be redeemed only if it is fully paid-up. The shares are redeemed out of the profits that are available for distribution to its shareholders or from the fresh proceeds issued for funding the redemption of preference shares.
Accounting for Preference Shares
In a financial statement of a company, redeemable preference shares are reported as a liability. The dividend paid on such shares is recorded as an expense in the income statement. In the case of irredeemable preference shares, the company does not have to retrieve and they are like ordinary shares.
So, they are recorded as part of the equity in the financial statement. Any return paid on such shares is treated as a distribution of profits and reported in the statement of changes in equity.
Preference Shares Formula
The formula for calculating Preference Share capital is as follows:
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Accounting Treatment of Redeemable Preference Shares
While redeeming the preference shares from the company’s profits, an amount that is equal to the face value of them is transferred to the capital redemption reserve. In order to immobilize profit from being used for any other purpose, the said procedure is necessary.
Redemption of Preference Shares Journal Entries
Only fully paid preference shares can be redeemed. On redemption, we repay the amount to the shareholders.
At the time of maturity of the preference shares, the journal entry passed is as under:
Both the Redeemable preference share capital account with the face value and the premium on redemption account is reduced by debiting the same. Such debited amounts are to be credited to Preference shareholders Account or Preference Share Redemption Account.
The main reason for crediting Preference Shareholders Account is to get sufficient time for arranging cash from different sources.
FAQs on Issue of Preference Shares: A Guide
1. What are preference shares as per the Companies Act, 2025-26?
Preference shares are a type of share capital that grants shareholders two main preferential rights over equity shareholders. Firstly, they have a right to receive a fixed dividend before any dividend is paid to equity shareholders. Secondly, they are entitled to the repayment of capital before equity shareholders in the event the company is wound up.
2. How do preference shares fundamentally differ from equity shares?
The key differences between preference and equity shares are rooted in rights and risk:
- Dividend: Preference shares receive a fixed rate of dividend, whereas the dividend for equity shares is variable and depends on the company's profits.
- Voting Rights: Preference shareholders typically do not have voting rights on company matters, while equity shareholders are the primary owners with full voting rights.
- Repayment of Capital: During liquidation, preference share capital is repaid before equity share capital.
- Redemption: Preference shares are issued for a fixed term and are redeemable by the company, which is not a feature of equity shares.
3. What are the main types of preference shares a company can issue?
Based on their features, preference shares can be classified into several types:
- Cumulative and Non-Cumulative: Cumulative shares allow unpaid dividends to accumulate and be paid in future years, while non-cumulative shares do not.
- Redeemable and Irredeemable: Redeemable shares can be bought back by the company. As per the Companies Act, 2013, all preference shares issued in India must be redeemable.
- Participating and Non-Participating: Participating shareholders can receive a share of the surplus profits after equity shareholders have been paid a certain dividend.
- Convertible and Non-Convertible: Convertible preference shares can be converted into equity shares after a specified period.
4. What are the key legal provisions for issuing preference shares under the Companies Act, 2013?
The issue of preference shares is governed by Section 55 of the Companies Act, 2013. The main provisions are:
- The company's Articles of Association must authorize the issue.
- A special resolution must be passed by the shareholders in a general meeting.
- All preference shares issued must be redeemable within a maximum period of 20 years from the date of issue.
- The company cannot issue any irredeemable preference shares.
5. Why would a company issue preference shares instead of taking a bank loan?
A company might opt for preference shares over debt for strategic financial reasons. Unlike the mandatory interest payments on a loan, dividends on preference shares are only payable out of distributable profits. This provides financial flexibility in lean years. Furthermore, issuing shares maintains a healthier debt-equity ratio on the balance sheet, which can be crucial for future borrowing capacity and investor perception.
6. From an investor's perspective, what is the main advantage of investing in preference shares over equity shares?
The primary advantage for an investor is the stability and predictability of income. Preference shares offer a fixed dividend, providing a more consistent return compared to the variable and uncertain dividends of equity shares. Additionally, preference shareholders have a higher claim on the company's assets and earnings, making it a relatively lower-risk investment than equity shares.
7. What is the accounting journal entry for the issue of preference shares at par?
The accounting for issuing preference shares at par involves two key journal entries:
1. On receiving the application money:
Bank A/c Dr.
To Preference Share Application A/c
2. On the allotment of shares:
Preference Share Application A/c Dr.
To Preference Share Capital A/c
This process officially records the capital raised through the issue in the company's books.
