Reference no: EM132680742

AASB 132 requires the classification of financial instruments, such as preference shares, to be determined by the substance of the contract which, in turn, is determined by the terms of the contractual arrangement. For instance, the substance expressed in the terms of the contract, determines whether a preference share issue should be accounted for as equity oras a liability by the issuer. The Rural Press case provides an example in which the accounting treatment led to a change in thesubstance of the contract. Concerns about how the company's preference share issue would be classified under AASB 132 were the driving force behind changes to the contractual terms of the preference shares.

• 4 The CaseRural Press Limited issued non-redeemable preference shares with a minimum dividend of 1.5 cents per share annum. The preferenceshares had been classified as equity in accordance with accounting standards prevailing at the time of the 2005 financial statements.
•  The company received the following advice from its auditors:"The Company has received advice from its Auditors that, asa result of the introduction of the new Accounting Standard AASB 132 (the Australian equivalent of International Accounting Standard IAS 32) dealing with the classification of financial instruments, and the requirement under the constitution of the Company that a dividend of 1.5 cents must be paid on Preferred Shares if there are sufficient profits to do so, it is likely that an amount based on the present value of future dividends of this 1.5 cent minimum payment will be required to be treated by the Company as a financial liability. An expense equivalent to the minimum annual dividend payment would similarly need to be recognised each year." (Notice of Meeting of Preferred Shareholders and Notice of Annual General Meeting 21 October 2005, notice dated 20 September 2005.)
• The auditors had advised that the preference share issue must be treated as a liability to the extent of the present value of the minimum 1.5 cents per share dividend in perpetuity. Management did not agree with the auditors' advice but proposed an amendment to the terms of the issue to remove uncertainty about the appropriate accounting classification of the preference shares. The proposal to make the minimum 1.5 cents per share dividend discretionary was accepted by shareholders.
• Thus the question of how to classify Rural Press Limited's non-redeemable preference shares with a minimum 1.5 cents dividend per annum did not arise in any financial statements to which AASB 132 applied.

Required

Assume the shareholders rejectthe directors' proposal, such that the minimum 1.5 cents per share dividend still applies of the non-redeemable preference shares.

Problem 1: How should the preference shares be accounted for in accordance with AASB 132? (Hint:the relevant principlesto guide this decision are stated inAASB 132, para. 11 definition of a liability, definition of equity; AASB 132, para. 15 requirement to recognise separately the components of an instrument, applying substance over form; AASB 132, para. 28.)You are notrequired to quantify your answer to this part.