Financial Accounting · Capital structure and finance costs

Ordinary Shares vs Preference Shares in ACCA FA

Updated 11 October 2026 · Fact-checked

Ordinary shares are equity: holders get dividends only if declared and share in residual profits. Preference shares carry a fixed dividend. Under IAS 32, irredeemable preference shares with discretionary dividends are equity. Redeemable preference shares, or those with mandatory dividends, are liabilities, and their dividends are finance costs in profit or loss.

Understand Share Capital: Ordinary and Preference Shares

A company raises money by issuing shares. Each share has a nominal (par) value, such as $1. The total nominal value of shares issued is the share capital in the statement of financial position. Any cash received above nominal value goes to share premium.

Ordinary shares are the main type. Holders own the company's residual value. They vote, and they receive dividends only when directors declare them. If the company is wound up, they are paid last. So they carry the most risk and the most potential reward. Ordinary shares are always equity.

Preference shares rank ahead of ordinary shares for dividends and for repayment on winding up. They usually pay a fixed rate, for example 6% of nominal value. They normally have no vote. Some are cumulative, meaning unpaid dividends carry forward. Some are redeemable, meaning the company must or may buy them back on a set date. Others are irredeemable, with no repayment date.

The key exam point is classification. IAS 32 looks at substance, not the name. If the company has an obligation to pay cash, the instrument is a liability. This applies if the shares must be redeemed, or if the holder can demand redemption, or if the dividend must be paid. If the company has no obligation, the shares are equity.

This matters because the treatment differs. Equity dividends are shown in the statement of changes in equity as a distribution. Liability preference dividends are a finance cost in profit or loss, and the shares sit in non-current liabilities (or current if due within 12 months). Profit, gearing and equity all change as a result.

Key formulas to remember

Share capital: Share capital = number of shares × nominal value per share; Only nominal value goes to share capital. Any excess received goes to share premium.
Preference dividend: Dividend = number of shares × nominal value × dividend rate; The rate applies to nominal value, not to issue price.
Classification rule (IAS 32): Obligation to pay cash (redemption or dividend) → liability; no obligation → equity; Judge by substance and contract terms, not by the word 'share'.
Accounting for liability preference shares: Dividend: Dr Finance costs, Cr Cash/Payables. Shares: shown in liabilities; Do not put these dividends in the statement of changes in equity.
Accounting for equity preference shares: Dividend: Dr Retained earnings, Cr Cash. Shares: shown in equity; Recognise the dividend only when it is declared or appropriately authorised.

How to solve Share Capital: Ordinary and Preference Shares questions

Use this method for any question on share types or their classification.

1Identify the type of share: ordinary, or preference. Note the dividend rate and nominal value.
2Check for any obligation: is redemption required or at the holder's option? Is the dividend mandatory?
3Classify: any obligation means liability. No obligation means equity. Ordinary shares are always equity.
4Calculate amounts: number of shares × nominal value for capital, and × rate for the dividend.
5Place the dividend: finance cost in profit or loss if liability; distribution in the statement of changes in equity if equity.
6Place the shares: non-current liabilities (or current if due within 12 months) or equity.
7Check the effect on the question asked, such as profit, total equity or gearing, before choosing your answer.

Quickest way: Obligation test in ten seconds

When to use it: Use it for multiple choice and multiple response questions asking how a share type is classified or where its dividend is shown.

Look for the words 'redeemable' or 'mandatory dividend'. Either one signals liability.
If the shares are irredeemable with discretionary dividends, say equity.
Liability means finance cost. Equity means distribution.
For numbers, compute shares × nominal × rate and stop.

Common mistakes in Share Capital: Ordinary and Preference Shares

Treating all preference shares as equity.
The word 'share' suggests ownership.
Fix: Apply the obligation test. Redeemable or mandatory-dividend preference shares are liabilities.
Putting liability preference dividends in the statement of changes in equity.
Students link dividends with distributions automatically.
Fix: If the shares are a liability, the dividend is a finance cost in profit or loss.
Calculating the dividend on issue price instead of nominal value.
Share premium and issue price get mixed up with par value.
Fix: Dividend rate always applies to nominal value unless the question says otherwise.
Treating the ordinary dividend as an expense.
Confusing it with finance costs on liabilities.
Fix: Ordinary dividends are a distribution of profit and never appear in profit or loss.
Including premium in share capital.
Students add up total cash received.
Fix: Share capital holds nominal value only. Credit the excess to share premium.

Worked examples

Example 1

A company has in issue 200,000 $1 irredeemable preference shares with a 5% dividend payable at the directors' discretion. Profit before finance costs is $400,000 and tax is ignored. Dividends of $10,000 on these shares are declared and paid. What is the profit for the year, and where are the shares shown?

Show the solution

Test for obligation: the shares are irredeemable and the dividend is discretionary, so no obligation exists.
Classification: equity.
Dividend: 200,000 × $1 × 5% = $10,000, a distribution in the statement of changes in equity, not a finance cost.
Profit for the year = $400,000, as no finance cost is charged.

Answer: Profit for the year is $400,000. The shares are shown in equity, and the $10,000 dividend is a distribution.

Example 2

A company has 100,000 $1 redeemable preference shares with an 8% mandatory dividend. Profit before finance costs is $250,000 and tax is ignored. What is the profit for the year and the classification of the shares?

Show the solution

Test for obligation: the shares are redeemable and the dividend is mandatory, so the company must pay cash.
Classification: liability.
Finance cost = 100,000 × $1 × 8% = $8,000.
Profit for the year = $250,000 − $8,000 = $242,000.

Answer: The shares are a liability. The finance cost is $8,000, so profit for the year is $242,000.

Exam tips

Read the terms of the preference shares for the words 'redeemable' and 'mandatory' before anything else.
In multiple response questions, select exactly the stated number of options and check each against the obligation test.
In number entry questions, check whether the answer is before or after the finance cost.
Remember that gearing rises when preference shares are classified as liabilities.

Practice questions from Capital structure and finance costs

Share Capital: Ordinary and Preference Shares in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Share Capital: Ordinary and Preference Shares: frequently asked questions

What is the difference between ordinary and preference shares?

Ordinary shares carry votes and receive variable dividends only when declared. Preference shares usually have a fixed dividend rate, rank ahead of ordinary shares and normally carry no vote.

When is a preference share a liability?

It is a liability when the company has a contractual obligation to pay cash. This happens if the shares must be redeemed, can be redeemed at the holder's option, or carry a mandatory dividend.

How are redeemable preference shares accounted for?

They are shown as a liability, non-current unless due within 12 months. Their dividends are a finance cost in profit or loss, not a distribution.

Can irredeemable preference shares be a liability?

Yes, if the dividend is mandatory. With no redemption date but a compulsory dividend, the company has an obligation to pay cash, so it is a liability.