Accounting Treatment Of Convertible Redeemable Preferred Stock And Its Economic Consequences

In the process of world economic globalization,the easing of financial policy makes innovative capital instruments such as embedded derivative financial instruments emerge in an endless stream,and embedded derivative financial instruments are collectively referred to as hybrid instruments.The inherent complex nature of hybrid tools makes it difficult and controversial to deal with accounting in practice.Therefore,the study on the accounting treatment and its economic consequences of the hybrid instrument represented by convertible and redeemable preferred stock can provide targeted Suggestions for the revision of accounting treatment in practice and the improvement of IASB standards.In the study of the accounting treatment of convertible redeemable preferred stock,this paper first studies the reasons for the frequent accounting treatment disputes.First,IASB and FASB standards have common defects.The historical evolution of the criterion in the division of liabilities and equity is essentially the dividing line between liabilities and equity which is repeatedly adjusted.However,the hybrid instrument has both debt and equity attributes,so the current standard still cannot reasonably distinguish its accounting attributes.IASB expands the scope of liabilities and classifies all mixed instruments that do not conform to the definition of equity as liabilities,which easily leads to the heterogeneity of liabilities in the balance sheet.Although FASB has introduced the concept of mezzanine equity,it still needs to clarify the definition of liabilities and equity to ensure that there are significant differences between different types of financial instruments in liabilities and mezzanine and equity.Second,IASB and FASB have different concepts on the distinction between liabilities and equity.IASB,based on the entity view,pays more attention to the economic resources of the whole enterprise.Financial instruments are therefore treated as liabilities if their contractual terms increase the risk to the entity of delivering economic resources.FASB,however,is more concerned with the economic interests of business owners based on industry subjectivity.Therefore,if the contract terms of a financial instrument are closely related to the equity value of the entity itself,it is regarded as an equity.Thirdly,stakeholders,laws,regulators and other market participants have different standards for classifying the accounting attributes of convertible and redeemable preferred shares,which makes some market participants disagree with the classification results at the standard level.Stakeholders focus on the analysis of the impact of the issuance of convertible and redeemable preferred stock on their potential economic interests.Legal institutions consider preferred stock not a liability and treat it as an equity.Financial regulators only focus on whether the contract terms will bear the loss of the enterprise.Then,this paper takes xiaomi company as a case to study the accounting treatment in practice.Xiaomi classified the convertible and redeemable preferred stock as a financial liability,but it did not pay a fixed dividend in the transaction process,and there was no outflow of economic benefits,which reflected the property of rights and interests,which was in contradiction with the identification result of its nature.In the process of fair value estimation,the discounted cash flow method is adopted,which is not applicable to the preferred stock valuation where the complicated issuance terms make the future cash flow cannot be reliably predicted.In addition,the higher the valuation of the preferred stock included in the financial liabilities,the greater the book loss,and there is the problem of excessive volatility of earnings.In the study of economic consequences under different accounting treatment methods,this paper first analyzes the adverse economic consequences of accounting treatment of xiaomi.Xiaomi USES the third level of fair value to measure the input value,which relies on the negligence of the management,to drive up the valuation of the preferred stock,and records the change of fair value into the current profit and loss,resulting in a huge book loss.Failure to pay a dividend on the grounds of lack of distributable profits is contrary to the payment of a fixed dividend.In addition,xiaomi disclosed that the huge book loss was caused by the increase in the valuation of the preferred stock,which was not a real loss,so it used the relevant disclosure to weaken the investment risk.Then,this paper provides a correction plan for xiaomi: first,the inclusion of mezzanine interests in reference to FASB is more in line with the economic essence of the transaction without the outflow of actual economic benefits.Second,the changes in the fair value of financial liabilities caused by valuation are unrealized gains and losses and are prone to excessive fluctuations in earnings.Therefore,they are included in financial liabilities while the fair value changes in other comprehensive earnings,so as to prevent the huge book losses caused by the increase in valuation under the original method.Third,make up for the lack of risk disclosure by using the original method and forcing disclosure of the order in which all financial liabilities are paid.Finally,the economic consequences of the three schemes are compared.Because the mezzanine interest is not directly included in the total equity,and the change in fair value will not affect the net profit.Compared with the abnormal high asset-liability ratio and negative net profit caused by plan 3 and the abnormal high equity multiplier caused by plan 2,the capital structure and distributable profit presented by the mezzanine equity method are more in line with the real business situation of qualified listing of xiaomi.This paper adopts experimental research method to study the cross influence of presentation and disclosure on investors' risk assessment and stock value assessment.When the original stock value correlation was disclosed in accordance with the presentation of plan 3,the score of investors' investment risk assessment was lower than that in the presentation of plan 3 alone,while the score of stock value was higher.However,when the payment order of financial liabilities is disclosed according to the presentation of plan 1,the score value of investors' investment risk assessment increases to a certain extent compared with the score value of the presentation of plan 3 alone,while the score value of stock value assessment decreases.This paper refers to the above situation that the stock price of xiaomi company is inconsistent with its real business situation,and combines the survey results that investors pay more attention to the evaluation of investment risk when making decisions.It believes that compared with the stock value,enterprises should truthfully reflect and fairly disclose their investment risks.Therefore,xiaomi should combine plan 3 with plan 2,include the convertible and redeemable preferred stock into the mezzanine interest and disclose the order of payment,so as to alleviate the existing defects and disputes in practical accounting treatment.Finally,this paper proposes some Suggestions for the revision of IASB standards.First,setting up a mixed instrument subject to be listed between liabilities and equity avoids the problem of repeatedly adjusting the dividing line between liabilities and equity.Second,IASB should not only focus on the economic substance of some clauses in the contract,such as redemption right,but should properly consider the overall economic and risk characteristics of the mixed instrument contract and judge various possible results and the impact on the cash flow.Thirdly,the interval supplementary measurement model is adopted in inactive markets to limit the manipulative risk.The lowest to highest range of the third level fair value estimate is disclosed in the notes.Fourthly,financial liability ranking method is adopted to disclose financial liabilities of enterprises in the order of payment,so as to ensure the complete information about the characteristics of solvency is disclosed in the notes.