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Brace for bigger liabilities on the balance sheet and a larger ratio of liabilities to equity if the Financial Accounting Standards Board stays the course in redefining preferred stock as a liability.

As complexity of financial engineering has blurred the line between liabilities and equities, FASB is working on a comprehensive project to help redefine where various items belong on the balance sheet. So far, the Board has stated its preference for a “basic ownership” approach. That would result in preferred stock, long regarded as equity, being reclassified as a liability, according to Charles Mulford, director of the Georgia Tech Financial Analysis Lab.

“Under the basic ownership approach, they’re defining equity as the last claim, the essence of what ownership is,” Mulford says. “It’s the last in line if the company fails, but the first to reap the rewards of success.” Preferred stock would be seen as a liability instead of equity because it carries a required dividend payment.

A recent Georgia Tech study examined 746 companies with outstanding preferred stock and positive shareholder’s equity across 10 broad industry sectors, to see how the change might affect results. The study compared balance sheet and income statement measures of leverage, interest coverage, and pretax income to determine the likely effect of FASB’s plans.

In a report titled “FASB’s Basic Ownership Approach and a Reclassification of Preferred Stock as a Liability,” the lab determined that companies are likely to see an increase in overall liabilities, with an increase in the liabilities-to-equity ratio of 4.17 percent. The study found the median company would witness a 6.4 percent decline in pretax income and a 6 percent decline in times-interest-earned.

Mulford says those could be sobering changes for companies, with net income defined differently, because preferred dividends would be subtracted as an expense through earnings. He says companies likely will consider refinancing outstanding preferred stock with common equity or debt to offset the effects.