When preferred shares are cumulative preferred

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When preferred shares are cumulative, preferred dividends that are not declared in a given period are called dividends in arrears. When preferred shares are not cumulative (known as noncumulative), a dividend unpaid in any year is lost forever. Dividends in arrears are not considered a liability because there is no payment obligation and is still disclosed in financial statements. Convertible Preferred Convertible preferred shares give shareholders the option of exchanging preferred shares for common shares at a specified ratio. These shares give the security of preferred shares but also the option to convert to common share if market value increases significantly. For conversion, original amount paid for preferred shares is transferred to appropriate common share accounts. When investors convert their preferred shares to common shares, the company debits the preferred stock account and credits the common stock account. If the common stock price at the time of conversion is more than the par value of the preferred stock then the company debits retained earnings for the difference between the two prices. Regardless if preferred shares have no par/par values, the book value of the preferred shares is used to record conversion. The conversion does not result in a gain or loss to the corporation. Note that the market values of the shares during time of transaction are not considered in recording the transaction because corporations haven’t received any assets equal to fair market value. Redeemable and Retractable Preferred Redeemable preferred shares give the issuing corporation the right to purchase the shares from shareholders at specified future dates and prices. When is it advantageous for corporations to redeem shares to convert preferred shares into common shares. Retractable preferred shareholders can redeem shares at their option instead of the corporation’s.
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Redeemable/Retractable preferred shares are similar to debt. They both offer a repayment of principal investment. Contractual arrangements of this sort are known as financial instruments. Redeemable and Retractable shares are presented in the liabilities section of balance sheet. Liquidation Preference Most preferred shares have preference on corporate assets if corporation fails. The preference to assets may be for legal capital of the shares or for specified liquidating value. The liquidation preference establishes the claims of creditors and preferred shareholders. Statement Presentation of Shareholders’ Equity In shareholders’ equity section of balance sheet, contributed capital and retained earnings are reported. Within contributed capital, two classifications are recognized: 1. Share Capital. This category consists of preferred and common shares. Preferred shares are shown before common shares because of additional legal rights.
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