redeemable preference shares accounting

It depends what the accounting year end is and what type of question it is

If it’s a consolidation question, the likelihood is that the parent will hold some (or all) of these preference shares and thus you need to consider the cancellation of the parent’s investment against some (or all) of the preference shares in the subsidiary for the sake of the statement of financial position

In addition, the parent will have (should have!) recorded the actual or imminent receipt of preference share dividend and the subsidiary will have (or should have) recorded the actual or imminent payment of preference share dividend

These two need to be cancelled for the purposes of the consolidated statement of profit or loss

However, if it’s not a consolidation question, then it’s more likely a question requiring the preparation of a single entity’s financial statements from a trial balance and the information within the question will probably tell us that the preference shares were issued 3 months in to this current year and that a preference dividend has been paid for the first six months

So now you need to calculate how much dividend has accrued and not yet been paid for those final three months

It is frequently the case that the examiner does not highlight to you within the question the fact that you need to calculate and account for this three month accrual of preference dividend – so watch out for it

Within the trial balance – if you look – you’ll probably find in the debit column an amount that equates to six months’ worth of preference dividend and that will be the only indication that a three month accrual is required

If you look at the mini-exercises at the back end of the course notes you’ll find a section on loan interest and preference dividends (page 210) (question 4 bears a close similarity to your post)

The questions are all extracts from past exam questions and you’ll quickly become acquainted with the issue

Your post asked “does the information about the 6% need to be reflected somehow in the books?” The “6%” per se does not need to be reflected within the figures for the preparation of the financial statements

However, you do need that information to calculate that a full year’s preference dividend amounts to 6% x $40 million = $2,400,000

Then check the period of time that those preference shares have been in issue – say 9 months

So the finance charge for that first year will be 9/12 x $2,400,000 = $1,800,000

Now check the trial balance line “Preference dividend paid” and you’ll probably discover the figure $1,200,000

And that means that you need to reflect the three month accrued preference dividend of $600,000

But the actual information “6%” itself doesn’t need to appear within your answer

There is a third possibility for the treatment of the dividend. Say the year end is 31 March and we’re looking at preparing the financial statements to 31 March, 20X7 (the preference shares were issued on 1 April, 20X5). An exam question might say something like “The preference shares are redeemable at a substantial premium so the effective dividend rate is 10%”

It will also indicate that $2,400,000 has been paid during the year to 31 March, 20X6 and the figure for the preference shares in the trial balance is $41,600,000

Last year (to 31 March 20X6) it was calculated that the dividend paid was $2.4m but the true finance cost was $4m (10% x $40m)

So the ‘missing’ $1,600,000 has been added to the liability to arrive at $41.6m in the trial balance

This year’s finance charge should be 10% x $41.6m = $4,160,000, but only $2,400,000 (6% x $40,000,000) has been paid meaning an additional amount of $1,760,000 needs to be adjusted for ($4,160,000 – $2,400,000)

The adjustment will be:

Dr Finance costs $1,760,000 (SoPoL)
Cr Preference shares liability $1,760,000 (SoFP)

resulting in finance costs in the statement of profit or loss of $4,160,000 ($2,400,000 paid + $1,760,000adjustment) and a liability on the statement of financial position of $43,360,000 ($41,600,000 brought forward + $1,760,000 adjustment)

Has that helped?