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How to account for issue of preference shares

Preference shares issued at no cost

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A company enters into an arrangement with its trade creditors to defer payment. In return for this the creditors:

1.  Will be paid in full at some specifed but uncertain event in the future

2.  Will be paid interest calculated from the date of the invoice to the date of payment

3.  Are issued now, at no cost, redeemable preference shares (no rights at all other than what follows) £ for £ with the amount of their invoices outstanding (i.e. if they have £10k of outstanding debt, they get issued 10k £1 redeemable preference shares). Redemption terms are they get 50% of par if, at the company's option, they are redeemed within one year of the above specified but uncertain event OR 2x par at the earlier of 5 years from the above specified but uncertain event and disposal of more than 50% of the ordinary share capital.

Very generous, I'm sure you'll agree. Especially as the specified but uncertain event is now becoming more certain.

How do I account for the issue of the preference shares under FRS105? Obviously the prefs are debt rather than equity, but what is the Dr entry? I would have said that it, in effect, increases the cost of the original invoice but by 50% or 100%? If it's 50%, where do I put the other 50%?

Hopefully this is clear enough, but my brain is fried so if I need to expand, please let me know.

Replies (11)

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By peterpaice
01st Apr 2021 11:10

your opening post in unclear you say they are issued at no cost. But they are exchanging the debt that is owed to them into preference shares - which is consideration.

with the limited info the journal will be as follows

DR 10k (assume its sat in trade creditors)
CR 10k Preference shares account

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Replying to peterpaice:
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By alfredpennypinch
01st Apr 2021 11:17

No, they're not exchanging the debt. The original invoices remain outstanding and will be paid (point 1 of my post)

These prefs are being issued in addition to the above debt.

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By paul.benny
01st Apr 2021 11:25

To clarify (and simplifying slightly), if the uncertain event occurs, the company can choose pay 50% in a year's time or 200% in five years' time. And this is in addition to settlement of the original liability.

Do the creditors have any rights or is this entirely at the option of the company?

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Replying to paul.benny:
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By alfredpennypinch
01st Apr 2021 11:32

Your clarification is correct.

Except to get paid what they're owed, the creditors have no rights - it's all at the option of the company.

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Replying to alfredpennypinch:
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By paul.benny
01st Apr 2021 11:44

So on that basis, I interpret this as the company issuing free shares, for which the debit entry is to retained earnings. I’m not sure whether this is a distribution and so requires distributable profits to be lawful. Are the trade creditors arms length parties and did all receive the same offer?

I would deal with the difference between issue price and redemption price when redemption takes place - ie recognise at par today.

I'm interested in what happens to the prefs should the company choose to exercise neither option. Given that preference holders do have some rights, it raises the possibility of the holders being able to hold the company to ransom.

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Replying to paul.benny:
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By Tax Dragon
01st Apr 2021 11:48

paul.benny wrote:

Given that preference holders do have some rights, it raises the possibility of the holders being able to hold the company to ransom.

Alternatively, given that these folk seem to have no rights, it raises the possibility that 'preference shares' is a misnomer.

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Replying to paul.benny:
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By alfredpennypinch
01st Apr 2021 12:23

All trade creditors are arms length, all received (and accepted) the same offer.

The point about the transaction possibly being a distribution requiring distributable reserves is troublesome...

The company can't "exercise neither option". If it chooses not to redeem at 50% of par within 1 year of the uncertain event then it MUST redeem at 200% of par at the earlier of 5 years since the uncertain event or transfer of 50% of the ordinary share capital (i.e. if the original owners sell up and exit then the prefs must be redeemed at that point).

The creditors can't demand redemption before these defined trigger points and the option to redeem within 1 year is entirely at the company's option.

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Replying to alfredpennypinch:
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By paul.benny
01st Apr 2021 12:53

I think it's time to take a more detailed look at some of the documentation supporting this scheme. Given the complexity, and the need for it to be binding on creditors (to stop them seeking CCJ), I would assume that a lawyer was involved. And unlike most other accounting matters, there are questions of law involved.

Either the lawyer had a different view of where the debit entry should go. Or they didn't consider it.

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By alfredpennypinch
01st Apr 2021 12:28

Oh, and thank you very much. Your advice is much appreciated.

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Replying to alfredpennypinch:
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By paul.benny
01st Apr 2021 12:54

You're welcome. It's an interesting question, if touch obscure.

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By frankfx
01st Apr 2021 13:20

How much are lawyers charging to ensure the new shares and rights are suitable,?
Are lawyers taking preference shares in settlement??
Outside solicitor ethics,?

Would an insolvency practitioner devise a better solution?

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