Preferred Stocks

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Background Hearts ‘R Us (“Hearts”), a young private research and development medical device company, sold $3.5 million of its Series A Preferred Shares on November 30, 2011 to Bionic Body (“Bionic”). This transaction gave the company enough financing for their heart valve system which they hope will revolutionize the way heart valve defects are repaired. In order to make this product available for sale they need a final approval by the FDA. The shares sold to Bionic have a par value of $1 per share and the purchase has given Bionic the following five rights: Board rights Mandatory Conversion Right Contingent Redemption Right Additional Protective Rights Right of First Refusal and Co-Sale Rights After Year 4, Hearts is still in…show more content…
In Thornton’s guidance, he provides a series of tests that Hearts can use to decide how to treat the preferred shares. The figure below belongs to Thornton’s article. 1. Are the Preferred Shares redeemable? Yes 2.Does the redemption feature provide a debt-like return? No Although Preferred Stock purchase agreement includes a contingent redemption right, it immediately fails the debt-like feature test. Bionic did not lend money to Hearts, and Hearts does not incur interest expense. Also, Conceptual Framework 6 suggests “preferred stock also often has both debt and equity characteristics, and some preferred stocks may effectively have maturity amount and dates at which they must be redeemed for cash.” This quote indicates that it is to the accountant’s best judgement. By following the the Thornton’s series of tests and the codification, Team 6 recommends Alternative A(1), classify the preferred shares in the equity section of the balance sheet. Alternative A(2) According to the same ASC 25-16, Hearts could classify it in the debt section because 25-16 states that classifying preferred stock as a debt instrument is more common. For example, one characteristic of the preferred share is Bionic’s Rights. The board, mandatory conversion, contingent redemption, and other rights could qualify a characteristic of a liability, “The

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