FA 43 - Shareholders' Equity

Summary

In this financial accounting module, the focus shifts to 'preferred shares,' a type of stock that offers certain advantages, particularly in bankruptcy scenarios where they are prioritized over common shares for repayment. The video explains that despite the appealing name, preferred shares may not always be the best investment, especially when considering their dividend preferences, which include the right to receive dividends before common shareholders and the feature of cumulative dividends. The script also touches on other attributes like convertibility, callability, retractability, and participation in dividends, setting the stage for a deeper dive into shareholder equity problems.

Takeaways

• 📚 Module 10 is a technical module focusing on shareholders' equity, with a new account called 'preferred shares' being introduced.
• 🎲 The instructor shares a personal anecdote about a board game called 'Stock Ticker' that incorrectly portrayed preferred shares as always better than common shares.
• 💡 The name 'preferred shares' might suggest they are superior, but this is not always the case and depends on the context of the investment.
• 🔄 Common shares typically offer more upside potential and are the more common form of investment when buying into a company.
• 🏦 Preferred shares are called 'preferred' primarily because they have priority over common shares in the event of a company's bankruptcy.
• 💰 Preferred shares often have dividend preference, meaning dividends must be paid to preferred shareholders before common shareholders can receive theirs.
• 📊 Cumulative dividends are a feature of some preferred shares, where if a dividend is missed, it accumulates and must be paid in the future.
• 🔄 Convertibility is an optional feature where preferred shares can be converted into common shares under certain conditions.
• 🛒 Callability allows the company to buy back preferred shares, which benefits the company rather than the shareholder.
• 🔄 Redeemability or retractability gives preferred shareholders the right to sell their shares back to the company under certain conditions.
• 🚀 Participating preferred shares allow for additional dividends if common shareholders receive more than the initially promised dividend amount.

Q & A

What is the main focus of Module 10 in the financial accounting course?

The main focus of Module 10 is on shareholders' equity, with a specific emphasis on a new account called preferred shares.

What was the speaker's childhood experience with the board game 'Stock Ticker'?

The speaker's experience with 'Stock Ticker' involved buying stocks based on dice rolls, where the price of the stock would go up or down accordingly. The game incorrectly treated preferred shares as having a multiplier effect on gains and losses compared to common shares.

Why did the speaker initially prefer preferred shares based on the board game?

The speaker initially preferred preferred shares because the game 'Stock Ticker' made them seem more advantageous due to the multiplier effect on stock price changes.

What is the common misconception about preferred shares based on their name?

The common misconception is that preferred shares are always better investments than common shares, due to the word 'preferred' in their name, which implies a higher status or benefit.

What are common shares and what rights do they give to shareholders?

Common shares are the most frequently issued type of share that gives the shareholder the right to participate in the company's gains and losses, with a focus on the potential for significant upside.

Why might preferred shares be considered 'preferred' in certain situations?

Preferred shares are considered 'preferred' mainly in the context of bankruptcy, where they have priority over common shares in the distribution of assets during liquidation.

What is dividend preference and how does it benefit preferred shareholders?

Dividend preference means that preferred shareholders must be paid dividends before any dividends can be paid to common shareholders. This ensures that preferred shareholders receive dividends first.

What is a cumulative dividend and how does it differ from a regular dividend?

A cumulative dividend is a feature of preferred shares where if a dividend is not paid in one period, it accumulates and must be paid in the future, in addition to the regular dividend for subsequent periods.

What are some optional features of preferred shares discussed in the script?

Some optional features of preferred shares include cumulative dividends, the ability to convert into common shares, being callable by the company, retractable by the shareholder, and participating in additional dividends paid to common shareholders.

What is the primary feature of preferred shares that the chapter will focus on?

The chapter will primarily focus on dividend preference and the feature of cumulative dividends for preferred shares.

Why might a company choose to issue preferred shares over common shares?

A company might issue preferred shares to provide certain benefits to investors, such as priority in dividend payments and asset distribution in case of bankruptcy, which can attract a different class of investors compared to common shares.

Outlines

00:00

📊 Introduction to Preferred Shares

This paragraph introduces the concept of preferred shares in the context of a financial and accounting course. The speaker uses a personal anecdote involving a board game called 'Stock Ticker' to illustrate a common misconception about preferred shares having more value than common shares. The speaker clarifies that while the name 'preferred shares' might suggest they are superior, this is not always the case. The main advantage of preferred shares lies in their priority during bankruptcy proceedings and often in dividend payments. The paragraph sets the stage for a deeper discussion on preferred shares and their unique attributes in subsequent lessons.

05:02

🏦 Features and Misconceptions of Preferred Shares

The second paragraph delves into the specific features of preferred shares, emphasizing their dividend preferences and the misconceptions surrounding them. The speaker explains that preferred shareholders are entitled to receive dividends before common shareholders, and if dividends are missed, they accumulate, a feature known as cumulative dividends. The paragraph also touches on other optional features of preferred shares, such as the ability to convert into common shares, being callable by the company, and having the potential for retractability and participation in dividends. The speaker indicates that while the focus of the course will be on dividend preferences and cumulative dividends, other features are important to understand in more advanced accounting contexts.

Keywords

💡Shareholders Equity

Shareholders' equity represents the ownership interest of shareholders in a company. It is the residual interest in the assets of the company after deducting liabilities. In the video, the module is focused on this concept, discussing various components including common shares and preferred shares, which are integral to understanding a company's financial structure.

💡Preferred Shares

Preferred shares are a type of equity security that ranks senior to common shares in terms of dividend payment and liquidation in the event of bankruptcy. The video script introduces this concept and explains that they are called 'preferred' primarily due to their priority in bankruptcy proceedings, as opposed to common shares which get paid last.

💡Common Shares

Common shares are the most basic form of corporate stock, providing shareholders with the right to participate in the company's profits and losses. The video emphasizes that common shares often have more upside potential compared to preferred shares and are the most common type of investment when buying into a company.

💡Dividend Preference

Dividend preference refers to the right of preferred shareholders to receive dividends before common shareholders. The script explains that this is a key feature of preferred shares, making them attractive to investors who prioritize steady income over capital gains.

💡Cumulative Dividends

Cumulative dividends are a feature of some preferred shares that ensure if a dividend is missed in one year, it is added to the dividend of the next year. The video script uses this as an example to illustrate the optional features of preferred shares, emphasizing the additional security it provides to investors.

💡Convertible

Convertible is a term used to describe a type of preferred share that can be exchanged for common shares at a predetermined rate. The script mentions this as an optional feature, highlighting the flexibility it offers to investors, allowing them to switch between preferred and common shares based on market conditions.

💡Callable

Callable refers to the feature that allows a company to buy back its preferred shares from shareholders. The video script explains this as a benefit to the company, giving it the option to reacquire shares, which can be advantageous in certain financial strategies.

💡Retractable

Retractable shares are those that can be sold back to the company by the shareholder if a buyer cannot be found. The script briefly touches on this feature, presenting it as a form of enforced liquidity for preferred shareholders.

💡Participating

Participating preferred shares allow the shareholders to participate in additional dividends paid to common shareholders beyond the fixed dividend rate for preferred shares. The video script explains this as an additional benefit, where preferred shareholders can receive more than the guaranteed dividend if the company performs exceptionally well.

💡Bankruptcy

Bankruptcy is a legal process that a company undergoes when it cannot repay its outstanding debts. The script discusses the priority of claims in bankruptcy, where preferred shareholders are paid before common shareholders, illustrating the 'preference' in the term 'preferred shares'.

💡Stock Ticker

Stock Ticker is a board game mentioned in the script that simulates the stock market. The game influenced the speaker's early perception of preferred shares, providing a personal anecdote to contrast with the actual financial definitions and implications of preferred and common shares.

Highlights

Introduction of a new account called 'preferred shares' in the context of shareholders' equity.

The speaker's childhood experience with the 'Stock Ticker' board game, which incorrectly represented preferred shares.

Misconception that preferred shares are always more advantageous than common shares, dispelled by the speaker.

Explanation of the term 'preferred shares' and its association with priority in bankruptcy scenarios.

Common shares usually offering more upside potential compared to preferred shares.

The main reason for the 'preferred' designation is the priority in dividend payments.

Preferred shareholders must be paid dividends before common shareholders can receive any.

Introduction of the concept of 'cumulative dividends' for preferred shares.

Cumulative dividends mean that missed dividend payments accumulate and must be paid in the future.

Optional features of preferred shares such as convertibility into common shares.

The company's option to buy back preferred shares, known as 'callable' shares.

Retractable shares, where preferred shareholders have the right to sell their shares back to the company.

Participating preferred shares, which allow for additional dividends if common shareholders receive more.

Focus on dividend preference and cumulative dividends as key features in the upcoming chapter.

The importance of understanding the nuances of preferred shares in shareholder equity problems.

Anticipation of exploring these concepts further in intermediate or advanced accounting classes.

Transcripts

welcome to module 10 of our financial

accounting course this module fairly

technical module on shareholders equity

now we're gonna touch on a lot of topics

common shares dividends things we

touched on before but we'll have a new

angle on them but there's gonna be a new

account introduced this chapter and I

want to discuss that account in this

video so in this video I want to focus

in on a new account called preferred

shares when I was a kid I had this board

game called stock ticker and the way it

worked is you rolled dice and you bought

stocks and based on your dice rolls the

price of the stock went up and down you

sold for more money and you were trying

to make more money than your friends and

of course I was a kid when I was a kid I

was obsessed with money and one of the

features in the game is you could buy

common shares or you could buy preferred

shares and the game actually didn't

treat preferred shares properly what it

did I'm going buy my best memory was it

had like a multiplier effect so if your

common shares went up by 10% while your

preferred shares were going up by 20%

like this whatever the common shares did

the the preferred shares would do more

if they fell the preferred servers would

fall by more and so my whole life and in

this game you were smart just to go for

preferred shares if you could so my

whole life up before I became an

accountant I just thought well if I'm

looking at investments preferred shares

are the ones to get because this stock

ticker game told me they were and also

because of the name right just look at

the name let's compare the two names

we've got preferred shares on top and

common shares below what would you like

you know just as a marketing exercise

here I would prefer to be a preferred

guest at a hotel I don't want to be a

common guest at hotel or an airline's

preferred customer I would prefer to

have preferred shares just the name

itself makes you think oh these are the

good ones

but in reality not necessarily so and

often not the case

most often if you're investing in a

company you are buying common shares and

common shares give us the right to

participate in the sort of gains and

losses the good and bad parts of owning

a company but mostly the good you're

thinking of the upside and common shares

tend to have way more upside then do

preferred shares and these are the

investments when you're investing in a

company you should be considering most

often or you will be considering most

often so what on earth then are

preferred shares well

preferred shares though the word

preferred actually focuses in on really

one thing we'll look at a couple of

reasons they're preferred or might be

preferred but really the main reason

they're preferred their called preferred

is because it's actually talking about

bankruptcy when the company goes

bankrupt and they're liquidating and

there's a lineup of creditors people the

company owed money to and they're trying

to get their money back out of this

company that's you know bankrupt and

can't afford to pay its bills preferred

shares are a head of common shares in

that line common shareholders get get

the money last right once the the bones

have been picked over by the vultures

common shareholders get their piece of

the pie preferred shareholders will get

made whole long before or right before I

should say common shareholders so they

have predation preference I think would

be the word if the company is insolvent

preferred shares get their money back

sooner also often not always the case

but often and I'll start writing this

down preferred shares will have dividend

preference and that's going to be the

key feature here is features related to

dividends or something our chapter kind

of focuses in on so the first thing is I

say dividend preference the idea here is

I can't pay a dividend to the common

shareholders until I first paid a

dividend to preferred shareholders so

they have a preference when it comes to

dividends and dividends is good way to

get money out of a company and so of

course that's that's a nice preference

to have right you get dividends first

so that's that's a key feature other

features and these are more optional

I'll say cumulative dividends and this

is something that will come up this

chapter so like let's say my common

shareholders expecting a $1 dividend and

I don't pay them it's kind of like well

you were expecting it but too bad you

know I gave you bad information I'm not

paying the dividend we don't have enough

cash too bad for you if the preferred

shares have this cumulative aspect if

they're expecting a dollar dividend

they'll get it and if they don't get it

they get a $2 dividend next year and if

they don't get that they get a $3

dividend next year it just piles up

that's what a cumulative dividend means

and that is a frequently cited feature

of preferred shares so that's you know

feature number one optional feature

number two and this is one that won't

come up in our chapter it's more for an

intermediate class convertible we can

have the option of a preferred chair to

convert to a common chair if we feel

like the common chair is the better way

to go you hear about this in Silicon

Valley it's not really done with

preferred shares as much its convertible

notes but they have notes payable that

convert into common shares the same can

be done with preferred shares they can

convert into common shares at some

agreed-upon rate the third thing is they

can be callable so this is where the

company can and redeemable zon other

word here this is where the company can

say hey we want to buy back your

preferred share so that's an option that

benefits the company not necessarily the

preferred shareholder but the company

has the option to sort of buy it back

they can also be what's the word

retractable I was gonna call it

redeemable retractable and that's almost

a flip side of the coin that's where the

preferred shareholder has a right to

sell their share just it's enforced

liquidity right if if you can't find a

buyer for me to sell this share you

company have to buy it back that's what

a retractable share is and five

participating and again

the gist of participating is we can't

pay our common shareholders until after

we've paid our preferred shareholders

dividends but let's say we want to pay

our common share oh let's say we

promised our preferred shareholders $1 a

year and we pay them their dollar and

our common shareholders we go oh we got

a lot of profit we're very profitable is

here we're gonna pay you $30 and because

common shares sort of steer the company

they can opt to pay them some bigger

dividend well if the preferred

shareholders are participating

it means listen if you're gonna pay the

common share there's more guess what you

got to pay us more - we are

participating in any dividends that they

get as well so those features are our

common ones our class is going to focus

in on this we're going to focus in on

the dividend preference the fact that

the dividends are cumulative - preferred

shareholders those are really gonna be

the features we focus in on but if you

take an intermediate or advanced

accounting class you could expect to

explore a lot of these other items okay

so I can't wait to get to some problems

in shareholders equity and you'll see

preferred shares all over those problems

all right that's all for this video stay

tuned for the next one