retractable/redeemable preferred shares

[torontobluered]

I'm supposed to look at the following situation and analyze its effect on the financial statements, especially debt/equity ratio:

"On January 1, 2012, DPI issued 30,000 redeemable and retractable preferred shares at a value of $10 per share. The shares are redeemable by DPI at any time after January 2015. The shares are retractable for $10 per share at any time up to January 2015, after which the retractable feature expires. The preferred shares require the payment of a mandatory dividend of $2 per share during the retraction period, after which the dividends become non- cumulative and non-mandatory (i.e., paid at the discretion of the board). Management recorded the issuance of the preferred shares by crediting an equity account."

IFRS applies.


I think it's fine that they credited equity since it doesn't really meet the requirements to be classified as debt (retraction nor redemption can be forced by the shareholders).

Not really sure how the retractable/redeemable options affect the accounting.

And I guess the dividend has to be accounted for as an expense every year up to 2015...but it's not prepaid so only $2 for each share is recorded for 2012.

Can you guys give me any more guidance? especially about how the retractable/redeemable features would affect the accounting? will be extremely thankful

 

[Marija]

Question

Hi,
Just wanted to ask you, from which text are you getting this question from?

 

[Fidget]

The shares are redeemable, they cannot therefore be equity as a liability exists whether or not the shares are actually redeemed.

 

[justin]

I want to know too please

 

[Counterofbeans]

From a US GAAP perspective, which I THINK is the same/similar to IFRS (I've examined the differences between the two before and I'm not recalling this situation popping out), the fact that it's redeemable/retractable is absolutely critical to the correct accounting treatment.

I would always start by asking myself a simple question: Is it mandatorily redeemable or not? If so, all bets are off and it's to be presented as a liability.

I do NOT see how these shares could be considered mandatorily redeemable (i.e. the obligation to transfer assets must be unconditional), so I would NOT record a liability at the time of issuance. Just because a redemption feature exists does not make it subject to ASC 480.

It appears we have a CONDITIONAL redeemtion feature here. The big question is, BY WHOM, the company/issuer or the holder?

If the redemption feature was solely (& I do mean solely) under the control of the issuer, you can present it as permanent equity, even for a U.S. public company.

If not, it's considered a, "debt security," but that doesn't necessitate liabiilty presentation, it just means it can't be recorded as permanent equity.

Here, DPI can (solely) redeem these shares, but only AFTER Jan 2015. Prior to that, these shares are retractable, which my understanding of that means that the investor/holder of the securities can put the shares back to the company for $10/share. This is NOT under the control of the company. (NOTE: I would want to examine the actual agreement to see how these, "retractable" shares really work)

As such, pursuant to SEC rules, these shares cannot be included as permanent equity. This means I'd show this as "mezzanine" equity (between debt and equity on the face of the balance sheet), which is an SEC reporting concept and has no analog under GAAP rules.

As such, I do not believe that permanent equity is the correct answer here.

NOTE: A nonpublic company may be able to get away with showing this as permanent equity, but I don't agree with that sentiment.

This really is a TEST question? I find this question far beyond what I would want to teach in school.