Preference Share

Definition

A preference share is a type of equity ownership in a company that provides shareholders with a fixed dividend, typically expressed as a percentage of the nominal value of the share, before any dividends are distributed to ordinary shareholders. It also has a higher claim on assets than ordinary shares in the event of bankruptcy or liquidation, although it ranks below debt obligations such as loan capital.

Examples

1. Dividend Terms: If a company issues 6% preference shares with a nominal value of $100, the shareholders will receive a fixed annual dividend of $6 per share irrespective of the company’s earnings.
2. Liquidation Scenario: In the event of liquidation, after all debts and loan capital are settled, the holders of preference shares will be paid on a priority basis before ordinary shareholders but after creditors.
3. Convertible Preference Shares: A company issues convertible preference shares, which the holders can convert into a specified number of ordinary shares after a certain period.

Frequently Asked Questions (FAQs)

1. What are preference shares?

   • Preference shares are types of equity shares that provide holders with fixed dividends and priority in asset distribution in case of liquidation over ordinary shares.

2. How do preference shares differ from ordinary shares?

   • Preference shares entitle holders to fixed dividends before ordinary shareholders and have a higher claim in the event of liquidation, whereas ordinary shares have variable dividends and lower claim priority.

3. Can preference shares be converted into ordinary shares?

   • Yes, some preference shares are convertible into ordinary shares under terms specified at issuance.

4. What happens to preference shares in liquidation?

   • Preference shareholders are paid out after debt obligations but before ordinary shareholders.

5. Are dividends on preference shares guaranteed?

   • Dividends on preference shares are typically fixed and paid out before any dividends to ordinary shareholders, but they depend on the company’s profitability and dividend policy.

Related Terms with Definitions

• Dividend: A distribution of a portion of a company’s earnings to shareholders, typically in the form of cash or stock.
• Liquidation: The process of bringing a business to an end and distributing its assets to claimants.
• Loan Capital: The borrowed funds used by a company, often in the form of loans or bonds, that must be repaid.
• Ordinary Share Capital: The portion of a company’s equity ownership that comes with voting rights and variable dividends.
• Preference Share Capital: The portion of a company’s equity that pertains to preference shareholders and includes the likes of dividend preferences and liquidation preferences.

Online References

• Investopedia: Preference Share
• Corporate Finance Institute (CFI): Preference Shares

Suggested Books for Further Studies

1. “Accounting for Non-Accountants” by Wayne Label
2. “Financial Accounting” by Jerry J. Weygandt, Paul D. Kimmel, and Donald E. Kieso
3. “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield

Accounting Basics: “Preference Share” Fundamentals Quiz

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