Arrearage

Definition of Arrearage

Arrearage is a financial term used to describe the state of being behind in payment of a financial obligation, whether it’s a loan, mortgage, bond interest, or dividends on cumulative preferred stock. When a borrower fails to make a payment by its due date, the amount becomes overdue and accrues as arrearage until it is paid.

Examples of Arrearage

Mortgage Arrearage: If a homeowner misses a mortgage payment in January and does not make it up, the missed payment becomes part of the mortgage arrearage. Until the January payment is made, plus any accrued interest or penalties, it remains in arrears.
Loan Arrearage: A borrower on a personal loan may fail to pay an installment due in a particular month. This unpaid installment will be counted in the arrearage balance.
Bond Interest Arrearage: When a bond issuer fails to pay interest payments on the scheduled date, the unpaid amount becomes bond interest arrearage.
Cumulative Preferred Stock Arrearage: Dividends that are not paid to the holders of cumulative preferred stock accumulate as arrearage and must be cleared before any dividends can be paid to common stockholders.

Frequently Asked Questions

What Causes Arrearage?

Several factors can lead to arrearage, including financial hardship, mismanagement of funds, or an unexpected expense that prevents making scheduled payments.

Is Arrearage the Same as Default?

No, while arrearage refers to being behind on payments, default typically refers to a more severe situation where the borrower has failed to meet the terms of the debt agreement altogether. Arrearage can lead to default if not addressed.

How Can Arrearage Affect Your Credit Score?

Credit bureaus may report arrearage, which can lower your credit score. The longer the arrearage remains, the more significant the impact on your creditworthiness.

What Steps Can Be Taken to Resolve Arrearage?

To resolve arrearage, one can negotiate with creditors for a payment plan, seek financial counseling, consolidate debts, or in some cases, refinance the debt.

Account Receivable (AR): Amounts due to a company for goods or services sold on credit.
Bad Debt: Debt that is written off when it becomes apparent the amount owed will not be collected.
Delinquency: Describes the state of being past due on legal financial obligations.
Default: Failure to fulfill the terms of a loan or credit agreement.

Online References

Suggested Books for Further Studies

“Principles of Accounting” by Belverd E. Needles, Marian Powers, Susan V. Crosson - An essential guide for accounting students.
“Financial Accounting Theory” by William Scott - A comprehensive book on financial accounting theories and applications.
“Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield - This book provides in-depth coverage of intermediate-level accounting concepts.

Fundamentals of Arrearage: Finance Basics Quiz

### What is arrearage in general terms? - [x] The amount of any past due obligation. - [ ] An advance payment made. - [ ] A financial asset. - [ ] A type of investment. > **Explanation:** Arrearage refers to an amount that is overdue and unpaid, covering various financial obligations. ### When does dividend arrearage occur? - [ ] When dividends are paid in advance. - [ ] When dividends are paid on time. - [x] When cumulative preferred stock dividends go unpaid. - [ ] When bond interest is paid early. > **Explanation:** Dividend arrearage happens when cumulative preferred stock dividends are overdue. These dividends must be paid before any common dividends. ### Can common dividends be paid if cumulative preferred dividends are in arrears? - [ ] Yes, always. - [x] No, not if the preferred dividends are in arrears. - [ ] Yes, but only half. - [ ] Yes, but it requires shareholder approval. > **Explanation:** Common dividends cannot be paid until any cumulative preferred dividends arrears are satisfied. ### What happens to arrearages on a cumulative preferred stock? - [ ] They are forgiven after one year. - [ ] They are converted to common stock. - [x] They accumulate and must be paid before common dividends. - [ ] They are converted into loans. > **Explanation:** Unpaid cumulative preferred dividends accumulate and must be paid before the firm can pay common dividends. ### What is a potential consequence of arrearage in a loan agreement? - [ ] Increased dividends. - [x] Late fees and legal action. - [ ] Reduced interest rates. - [ ] Higher credit scores. > **Explanation:** Arrearages in loan agreements can lead to late fees, higher interest rates, negative credit reporting, and potentially legal actions. ### What does arrearage indicate in the context of interest on bonds? - [ ] That interest has been paid on time. - [x] That interest payment is due and unpaid. - [ ] That interest payment is not required. - [ ] That the bond has matured. > **Explanation:** In the context of bonds, arrearage denotes the amount of interest that is due but unpaid. ### Can arrearage be resolved by restructuring debt? - [x] Yes, it can. - [ ] No, it cannot. - [ ] Only in some cases. - [ ] Only if the arrearage is less than 30 days overdue. > **Explanation:** Arrearage can often be resolved by negotiating new payment terms or restructuring debt. ### What is the difference between arrearage and delinquency? - [x] Arrearage quantifies the unpaid amount; delinquency indicates overdue status. - [ ] Delinquency quantifies the unpaid amount; arrearage indicates overdue status. - [ ] Both terms mean the same regarding unpaid obligations. - [ ] Neither term refers to overdue obligations. > **Explanation:** Arrearage specifies the unpaid amount, while delinquency indicates the state of being overdue. ### Why is managing arrearage important for a business? - [ ] To increase tax liabilities. - [x] To maintain creditworthiness and avoid additional costs. - [ ] To increase shareholder dividends. - [ ] To delay paying creditors indefinitely. > **Explanation:** Managing arrearage is critical to maintain good credit, avoid late fees, and minimize borrowing costs. ### How does arrearage impact cumulative preferred stockholders? - [x] They must receive overdue dividends before common dividends are issued. - [ ] They lose their right to dividends. - [ ] They receive a double dividend immediately. - [ ] They convert their shares to bonds. > **Explanation:** For cumulative preferred stockholders, any unpaid dividends must be paid out before common shareholders can receive dividends.

Thank you for engaging with our detailed exploration of arrearage and tackling these informative quiz questions. Continue to enhance your knowledge in finance!