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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:
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.
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:
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.
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.
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.
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.

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