Thursday, December 11, 2008

Should Redeemable Preference Shares be treated as Debt or Equity?

Corporate houses that have issued redeemable preference shares are treating them as equity capital.

As per the International Financial Reporting Standards (IFRS), redeemable preference shares should be shown under the head long-term financial liability on the liability side.

The company law, in contrast, requires them to be classified as equity capital on the liability side.

The Institute of Chartered Accountants of India (ICAI) had suggested in its standards on financial instruments that companies treat them as long-term liability.

The changes would have impact on the bottom lines of companies negatively. Classifying redeemable preference shares under long-term financial liability will have an impact on the net profit of the company because it will change the way dividend paid on such shares is accounted for. If a redeemable preference share were treated as equity, the returns to those holding the instrument would be in the nature of dividends. On the other hand, if it were treated as long-term liability, the same would be interest, which would be an expense that would lower profits, at the same time it will reduce the tax burden of the company to some extent.

Hence should Redeemable Preference Shares be treated as Debt or Equity?

Contributed By:
Krishnendu Ghosh
(Globsyn Business School)