Unusual types of security: debt or equity?

Some companies issue unusual types of security that are difficult to classify as either debt or equity.

Details of three such issues are given below. They are taken from the notes to the 2001 accounts of certain large international companies.

(1) Redeemable preference shares of a subsidiary company On 30 March 2001, a wholly owned subsidiary of Company A issued perpetual, cumulative, nonvoting preference shares for a total amount of A205 million.

The preference shares have no voting rights. They are not redeemable, except at the exclusive option of the issuer, in whole but not in part, on or after the fifth anniversary of the issue date or at any time in case of certain limited specific pre-identified events including changes in taxation laws.

Should redemption occur, the redemption price would be equal to the par value together with dividends accrued, but not yet paid.

CHAPTER 12 • SHAREHOLDERS’ EQUITY 391 From the issue date to the fifth anniversary of the issue date the preference shares will carry a dividend based on a variable 6-month Euribor rate. Beyond the fifth anniversary, the dividend rate will increase by an additional 2% per annum, in line with market conditions for such instruments.

The dividends are payable semi-annually from the issue date. The preference shareholders will benefit from a limited Company A guarantee covering the subsidiary’s obligations under its shares.

(2) Undated subordinated notes Company B issued, on 29 Septem illion Auction Rate Coupon Undated Subordinated Notes. These notes may be redeemed at the option of the issuer except in certain exceptional circumstances, including any failure to pay interest when due, when they may be redeemed at the option of their holders.

They rank pari passu (i.e. equally) with holders of other subordinated indebtedness. Interest is payable semi-annually, at variable rates based on Euribor. The payment of accrued interest may be suspended if both of the following conditions are satisfied:

(i) the annual non-consolidated accounts of Company B show an absence of income available for distribution;

(ii) the annual consolidated accounts of Company B show that the consolidated net income available for distribution to common shareholders is less than or equal to zero.

(3) Non-voting participating securities Company C issued 100,000 non-voting participating securities in ecus in 1984. The non-voting participating securities are not redeemable. Their remuneration is included in financial charges. These securities were converted into euros in 1999.

Each security carried a coupon that gave the holder the right to subscribe to a new non-voting participating security until February 1987. There were 94,633 securities resulting from the exercise of the coupons.

The remuneration of the 194,633 non-voting participating securities comprises a fixed interest element of 60% of the nominal value of the security and equal to 7.5% per annum and a variable amount on the remaining 40% based on the consolidated net income of the previous year within the limits fixed in the prospectus.

Required Consider each of the above issues of securities. How should the issuing company present the securities in its accounts under IAS? Give reasons for your decision.

AppenedixLO1