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Preferred stock (also called preferred shares or preference shares) is a class of ownership in a reporting entity that is senior to common stock and subordinate to debt. The terms of preferred stock can vary significantly. A reporting entity may issue several series of preferred stock with different features and priorities such as on dividends or assets in case of liquidation. Preferred stock may have characteristics of equity, debt, or both. Figure FG 7-1 summarizes some of the common characteristics of preferred stock.
Figure FG 7-1
Characteristics of preferred stock
Feature
Overview
Liquidation preference
Preferred stock holders have a claim on an issuer's assets senior to common shareholders and subordinate to bondholders and other creditors
Dividends
Generally, preferred stock holders receive dividends before common shareholders; the dividend is typically fixed and may be cumulative or non-cumulative
Preferred stock holders may be entitled to receive additional dividends when dividends are paid to common shareholders (participating preferred stock)
Voting
Preferred stock may be voting or nonvoting; some preferred stock may have voting rights for certain extraordinary events (e.g., a takeover of the issuer, the issuance of new shares)
Term
Preferred stock may be perpetual, mandatorily redeemable on a specified date, or contingently redeemable either upon election of the holder, occurrence of an event, or at a point in time
Conversion option
Convertible preferred stock either requires or permits the holder to convert the instrument into equity securities of the issuer. Some convertible preferred shares are convertible only upon the occurrence of a specified contingent event (e.g., upon an IPO).
Put option exercisable by the holder
Preferred stock may be puttable at the option of the holder after a certain period (e.g., 5 years), or upon the occurrence of an event (e.g., a change in control)
Call option exercisable by the issuer
Preferred stock may be callable at the option of the issuer after a certain period or upon the occurrence of an event (e.g., a change in credit rating or change in tax or regulatory capital treatment)

7.2.1 Redemption features

Preferred stock may or may not provide for redemption. Perpetual preferred stock does not have a redemption feature. Redeemable preferred stock may be mandatorily or contingently redeemable. The typical accounting classification for each of these types of preferred stock by the issuer is summarized in Figure FG 7-2.
Figure FG 7-2
Preferred stock redemption features*
Type
Liability or equity*
Mezzanine or permanent equity
Mandatorily redeemable without a substantive conversion option
Liability
Not applicable
Mandatorily convertible into a variable number of equity shares based on a fixed monetary amount
Liability
Not applicable
Mandatorily convertible into a variable number of equity shares when the monetary value is based on other than the fair value of the issuer’s equity shares (e.g., S&P 500 index)
Liability
Not applicable
Mandatorily redeemable with a substantive conversion option
Equity
Mezzanine equity
Redeemable (puttable) at the holder’s option
Equity
Mezzanine equity
Contingently redeemable (puttable) at the holder’s option
Equity
Mezzanine equity
Redeemable (callable) at the issuer’s option
Equity
Permanent equity
Contingently redeemable (callable) at the issuer’s option
Equity
Permanent equity
No redemption (perpetual preferred stock)
Equity
Permanent equity
* See FG 7.3.1 for more details on when preferred stock should be classified as a liability under ASC 480.
When a preferred share is redeemable (or contingently redeemable) at the option of the issuer, permanent equity classification assumes the holder does not control the board of directors (or could not control the board as a result of events outside the issuer’s control, such as a debt default). In that case, the preferred shareholders, in effect, are able to force the issuer to redeem their shares for cash.
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