Definition
Dividends in arrears refer to dividends on cumulative preferred stock that are due and have been declared but have not yet been paid by the due date. While regular dividends are distributions of profits to shareholders, dividends in arrears specifically relate to cumulative preferred stockholders who are guaranteed their dividends before any dividend payments are made to common stockholders.
Examples
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Example 1: XYZ Corp. – XYZ Corp. has cumulative preferred stock that guarantees a dividend of $5 per share. If the company fails to pay this dividend in 2020, the $5 per share would be in arrears and must be noted in the financial statements.
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Example 2: ABC Inc. – ABC Inc. missed dividend payments for two consecutive years on its cumulative preferred stock. The company declared $3 per share each year; thus, it owes $6 per share in dividends in arrears, which need to be disclosed in the notes of its financial statements.
Frequently Asked Questions
What are dividends in arrears?
Dividends in arrears are unpaid dividends on cumulative preferred stock that have been declared but not yet disbursed to shareholders.
How are dividends in arrears recorded in financial statements?
Dividends in arrears must be disclosed in the notes to the financial statements, providing transparency regarding the company’s obligations to cumulative preferred shareholders. They are not recorded as a liability until they are declared.
Are dividends in arrears paid before common stock dividends?
Yes, dividends in arrears on cumulative preferred stock must be paid before any dividends can be distributed to common stockholders.
Do dividends in arrears accumulate interest?
Typically, dividends in arrears do not accumulate interest unless specifically stated in the stock agreement.
Can dividends in arrears affect a company’s credit rating?
Yes, persistent dividends in arrears can signal financial instability and may negatively affect the company’s credit rating.
- Cumulative Preferred Stock: Type of preferred stock where omitted dividends accumulate and must be paid out before any dividends can be paid to common stockholders.
- Non-Cumulative Preferred Stock: Type of preferred stock that does not entitle the shareholder to claim unpaid or omitted dividends in future periods.
- Dividend Policy: A company’s approach to distributing profits to its shareholders, defining the frequency and amount of dividend payments.
- Financial Statements: Written records that convey the business activities and the financial performance of a company, including the balance sheet, income statement, and cash flow statement.
- Preference Dividend: Dividends that are paid to preferred shareholders before any dividends are paid to common shareholders.
Online References
- Investopedia: Dividends in Arrears
- AccountingTools: Dividends in Arrears
- Corporate Finance Institute: Preferred Dividends
Suggested Books for Further Studies
- “Financial Accounting: An Introduction to Concepts, Methods and Uses” by Roman L. Weil
- “Accounting for Non-Accountants: The Fast and Easy Way to Learn the Basics” by Wayne Label
- “Intermediate Accounting” by Donald E. Kieso
Accounting Basics: “Dividends in Arrears” Fundamentals Quiz
### What are dividends in arrears?
- [ ] Dividend payments made in advance.
- [x] Declared dividends on cumulative preferred stock that haven't been paid by the due date.
- [ ] Unpaid dividends on common stock.
- [ ] Dividends paid in the future for past earnings.
> **Explanation:** Dividends in arrears are declared dividends on cumulative preferred stock that remain unpaid by their due date.
### How must dividends in arrears be disclosed?
- [ ] As a liability on the balance sheet.
- [x] In the notes to the financial statements.
- [ ] In the income statement.
- [ ] On the cash flow statement.
> **Explanation:** Dividends in arrears must be disclosed in the notes to the financial statements. They are not always recorded as liabilities unless declared.
### Are dividends in arrears accumulated for non-cumulative preferred stocks?
- [ ] Yes, always accumulates.
- [ ] Only if the company decides.
- [x] No, they are not accumulated.
- [ ] Yes, but without interest.
> **Explanation:** Dividends in arrears do not accumulate for non-cumulative preferred stocks. Only cumulative preferred stocks have such provisions.
### When are dividends in arrears paid?
- [ ] They are never paid.
- [ ] Only during company liquidation.
- [x] Before any dividends to common stockholders.
- [ ] Along with common stock dividends.
> **Explanation:** Dividends in arrears on cumulative preferred stock must be paid before any dividends can be distributed to common stockholders.
### Do dividends in arrears reflect on a company's financial health?
- [x] Yes, they indicate missed obligations.
- [ ] No, they are standard practice.
- [ ] They only indicate a future payable.
- [ ] Only in special cases.
> **Explanation:** Dividends in arrears indicate a company's missed obligations and may signal financial instability, affecting investor confidence.
### Can dividends in arrears accrue interest automatically?
- [ ] Yes, just like regular debts.
- [ ] Only for non-cumulative preferred stocks.
- [x] No, unless specifically stated in the stock agreement.
- [ ] Yes, as per IRS regulations.
> **Explanation:** Typically, dividends in arrears do not accrue interest unless specifically stated in the stock agreement.
### What is cumulative preferred stock?
- [x] Stock where omitted dividends accumulate.
- [ ] Stock without dividend voting rights.
- [ ] Stock prioritized lower than common stock.
- [ ] Non-transferable stock.
> **Explanation:** Cumulative preferred stock is a type of stock where omitted dividends accumulate and must be paid out before any dividends to common shareholders.
### Why must dividends in arrears be disclosed in financial statements?
- [x] To inform stakeholders of the company's obligations.
- [ ] To adjust the earnings per share calculation.
- [ ] To show long-term liabilities.
- [ ] For calculating taxable income.
> **Explanation:** Disclosing dividends in arrears in financial statements informs stakeholders of the company's financial obligations and potential risks.
### What might occur if dividends in arrears continue over multiple years?
- [x] The company's credit rating could decline.
- [ ] Preferred shareholders lose voting rights.
- [ ] The stock price will certainly increase.
- [ ] The debt to equity ratio improves.
> **Explanation:** Persistent dividends in arrears can signal financial distress, leading to a potential decline in the company’s credit rating.
### To which type of preferred stock do dividends in arrears apply?
- [ ] Non-cumulative preferred stock
- [x] Cumulative preferred stock
- [ ] Convertible preferred stock
- [ ] Callable preferred stock
> **Explanation:** Dividends in arrears specifically apply to cumulative preferred stock, as this stock ensures that omitted dividends must be paid in the future.
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