Accounts Demystified, 6th Edition

f u r t h e r f e at u r e s o f c o m p a n y a c c o u n t s

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which is greater than the original loan amount. Thus the bond is effec-

tively paying interest; you just don’t get it until the end of the term.

How do you account for a zero coupon bond, then? Is the liability the initial amount

or the final amount?

The liability starts as the amount of cash received for the bond, but the

liability increases each year. As I said, interest is effectively paid on this

type of loan, and we can work out what the effective interest rate is. We

then increase the liability by this interest rate each year so that, at the

end of the term, the liability has grown to the final lump sum payment.

The other book-keeping entry is to reduce retained profit each year by the

effective interest for the year.

Equity

As we saw in the last session, Wingate has only one type (or class as it

is known) of share capital – ordinary shares. These are by far the most

common shares you will encounter. Just as with debt, though, there are

variations.

Preference shares

The shares you are likely to encounter most often after ordinary shares

are preference shares. They are different from ordinary shares in that:

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They usually have a fixed annual dividend, which must be paid

before any dividend is paid on the ordinary shares. Unlike interest,

though, these dividends cannot be paid unless the company has

positive retained profit.

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If the company is wound up, the preference shareholders usually

get their money back before any money is returned to the ordi-

nary shareholders. The amount they get back will, however, be

the amount they put in or some other predetermined amount. The

ordinary shareholders get what is left over, which may be a lot

more than they put in or a lot less.

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The result of this is that preference shares are less risky than ordinary

shares because they come before the ordinary shares in everything (hence

the name preference), but there is less opportunity for the preference

shares to become worth a huge amount.

There are many variations on simple preference shares. For example:

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Sometimes a company may not be performing very well and may

not be able to pay a dividend in a particular year. Cumulative pref-

erence shares entitle the holders to get all their dividends due from

past years, as well as the current year’s, before any dividends can

be paid to ordinary shareholders.

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Sometimes preference shares include conditions whereby the divi-

dend on the shares will be increased (i.e. when the company does

particularly well). These are known as participating preference

shares.

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Some preference shares have a fixed date on which the company

must return the capital invested by the preference shareholders.

These are known as redeemable preference shares.

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Some preference shares can be converted into ordinary shares at a

certain time and certain price per ordinary share. These are known

as convertible preference shares.

As you can see, preference shares can actually be a lot of very different

things! Indeed, they can be all of these things at once, which gives you

this:

Cumulative participating redeemable

convertible preference shares

Under rule changes made some time ago, most preference shares are

now treated in a company’s accounts as loans. Legally, however, they are

still shares.

Other types of shares

A company can issue shares with more or less any terms and conditions it

chooses (provided the shareholders agree) and these shares can be called

whatever the company chooses.