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A fictional scenario…
Supposing an entity had in issue redeemable preference shares which paid a coupon of 6%. The principal is to be mandatorily converted to equity shares in five years’ time on redemption – there is no cash option.
On initial recognition, would this be considered debt or equity (or both)?
My inclination is that this is a compound instrument (assuming that the mandatory conversion to equity doesn’t impact on that). The preference dividends due are an obligation to deliver cash and hence, I believe that the present value of the future preference dividends would be classified as a financial liability and the difference between that amount and the undiscounted principal would be classified as equity.
Had there been an option to redeem the preference shares in cash then that future cash flow would also have been discounted to ascertain the debt element (thereby reducing the equity element).
Am I heading in the correct direction with my thoughts?
Thanks in advance.
Andrew
Hi
You have a persuasive argument but, I believe, the absence of a cash alternative and the mandatory conversion into equity makes it an equity instrument.
To be 100% I’d need to check it out but if you’re happy with my reply, then I won’t do it (you could always check it out for yourself!)
Hello Mike,
Thank you for your reply; that’s all the assurance I’d needed. I had a nagging thought that the lack of a cash option and mandatory equity conversion would be the decisive factors.
Once again, many thanks.
Andrew
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