Preference Shares

Preference shares are a distinct class of shares defined by Section 43 of The Companies Act, 2013. The key idea is that these shares carry two specific preferential rights — one over dividends and another over capital repayment — which set them apart from equity shares.

The Two Essential Conditions (Section 43)

A share is classified as a preference share only if it meets both of the following conditions:

1. Preferential Right to Dividend: The shareholder has a right to receive a fixed dividend before any dividend is paid to equity shareholders. This dividend can be either:

   • A fixed amount per share (e.g., ₹10 per share), or
   • An amount calculated at a fixed rate on the nominal (face) value of the share (e.g., 9% of ₹100 = ₹9 per share).

2. Preferential Right to Repayment of Capital: In the event the company is wound up (liquidated), the preference shareholders have the right to get their capital back before any capital is returned to equity shareholders.

Additional Rights and Variations

Even though the two conditions above define a preference share, the company's Memorandum or Articles of Association can grant preference shareholders additional rights. This leads to different types of preference shares:

• Participating vs. Non-Participating: A participating preference share gives the holder the right to share in the surplus profits of the company (after equity shareholders have been paid a certain dividend), either fully or to a limited extent. A non-participating preference share only entitles the holder to the fixed preferential dividend and nothing more.

• Cumulative vs. Non-Cumulative: If dividends are not declared in a particular year, a cumulative preference share ensures that the unpaid dividend (arrears) accumulates and must be paid in future years before any dividend is paid to equity shareholders. A non-cumulative preference share does not carry forward unpaid dividends.

• Redeemable vs. Irredeemable: A redeemable preference share is one that the company can buy back (redeem) after a specified period. An irredeemable preference share can only be repaid when the company is wound up.

Accounting Treatment

The accounting treatment for the issue of preference shares is identical to that of equity shares. The only difference is the name of the share capital account.

Journal Entry for Issue of Preference Shares:

Balance Sheet Presentation (Extract):