The common and preferred are two different types of stock (also known as shares) that corporations issue to raise capital. The basic difference between common stock and preferred stock lies in the rights and opportunities that stockholders enjoy upon purchasing common or preferred stock of a corporation.
The common features of both types of stock are briefly discussed below:
It is the basic type of stock that every corporation issues. The person who purchases the common stock of a corporation becomes an owner of the corporation and is known as common stockholder.
The following are the basic rights of a common stockholder:
- Right to vote for the election of directors and certain other issues. Usually one share has one vote.
- Right to participate in the dividends declared by the directors.
- Right to receive the share of assets upon liquidation of the corporation.
In addition to common stock, many corporations issue preferred stock to raise fund. When a person buys the preferred stock of a corporation, he is known as preferred stockholder of that corporation. The rights and opportunities of a preferred stockholder are essentially different from those of a common stockholder.
The usual rights of a preferred stockholder are given below:
- The preferred stockholders have a preference over common stockholders as to dividend. The rate of dividend on preferred stock is usually fixed.
- If the preferred stock is cumulative, the stockholders have cumulative dividend rights.
- The preferred stockholders have a preference over common stockholders as to assets of the corporation upon liquidation.
- Preferred stockholders may have the option to convert their preferred stock into common stock. The preferred stock with such a feature is known as convertible preferred stock.
- Preferred stock may be callable at the option of the corporation.
From stockholders point of view, the negative aspect of preferred stock is that it does not have the voting power. It means, the preferred stockholders are not entitled to vote for the election of directors and other important matters of the corporation.
The different features of common stock and preferred stock discussed above appeal to different classes of investors. Therefore, many corporations prefer to issue both types of stock to attract as many investors as possible.
Balance sheet presentation:
Both common and preferred stock are reported in the stockholders’ equity section of the balance sheet. The proper presentation is shown below:
In above example, the company is authorized to issue 100,000 shares of preferred stock and 2,000,000 shares of common stock. Out of these authorized number of shares, only 50,000 shares of preferred stock and 1,000,000 shares of common stock have been issued. Notice that the amount of shares that have actually been issued and subscribed has been written in the amount column. The additional paid-in-capital for two classes of stock has also been presented separately. The additional paid-in-capital is the amount paid by stockholders in excess of the par value of common or preferred shares.
Reporting mandatorily redeemable preferred stock:
Special characteristics of preferred stock can affect its reporting in the balance sheet. For example, both International Financial Reporting Standards (IFRSs) and US-GAAP now require companies to report mandatorily redeemable preferred stock as liability rather than equity.