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What are the basic classes of equity?

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Common stock is the residual equity in a company in that all other financial claims against the firm have priority over this class of equity, it entitling its holders to dividends and liquidation proceeds after the claims of all creditors and preferred stockholders are satisfied and, generally, to voting rights and preemptive rightsProvisions concerning common stock are fundamental to the company law of most countries, every stock company having to have at least one share of common stock issued and outstanding.  If a corporation has only one class of equity, it is common stock.

Preferred stock is a form of equity evidencing ownership in the capital stock of the issuing company that has preference rights over its common stock.  These preferences right are typically:

  • A dividend of a fixed or minimum amount payable before dividends on common stock; and
  • The payment of dividends due but not yet paid before satisfying the claims of common shareholders upon the firm’s liquidation.

Preferred shares and similar instruments may be, in whole or in part, a liability, based on the contractual terms of the instrument.  The present value of the dividend payments on preferred shares is classified as a liability and treated as an expense, even though the shares are classified as equity.

A compound financial instrument is any nonderivative financial instrument that is comprised of both liability and equity components.  Split accounting is the bifurcation and separate measurement of the fair value consideration and presentation of the liability and equity components of a compound financial instrument upon it initial recognition under IFRS – under US GAAP, the instrument would be classified wholly within liabilities or equity.

Preferred Shares – US GAAP vs. IFRS
Mandatorily redeemable equity securities are reclassified and accounted for as a liability only once redemption becomes certain to occur. Equity instruments that can be put back to or redeemed by the issuer are accounted for as a liability.
Preferred shares that pay dividends are not necessarily subject to split accounting. Preferred shares that pay dividends are compound financial instruments and, thus, require split accounting,

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