Definition
A preference dividend (or preferred dividend) is a dividend that is promised to holders of preferred or preference shares. Preference shares are a type of equity security that typically offers a fixed dividend payout and have priority over common shares in dividend payments and asset distribution in the event of liquidation. Preference dividends are often fixed and can be either cumulative or non-cumulative, depending on the terms set by the issuing company.
Examples
-
Fixed Annual Payout: Company ABC issues preferred shares with a 5% fixed annual dividend. If a shareholder owns 100 shares priced at $100 each, they would receive a preference dividend of $500 annually.
-
Cumulative Preference Shares: If a company is unable to pay a preference dividend in a given year, the unpaid dividend accumulates for holders of cumulative preference shares. For example, if Company XYZ missed paying dividends in 2022 and 2023, it must pay these arrears in addition to the dividend for 2024 before any dividends can be paid to common shareholders.
-
Non-Cumulative Preference Shares: For non-cumulative preference shares, if a dividend is skipped, shareholders do not have the right to claim it in the future. This is different from cumulative preference shares, which require the company to pay any missed dividends before common stock dividends are issued.
Frequently Asked Questions
What is the difference between preference and ordinary dividends?
Preference dividends are typically fixed and paid out to preferred shareholders before any dividends are distributed to ordinary (common) shareholders. Ordinary dividends, on the other hand, may vary year to year and are subject to availability after preference dividends have been paid.
How is a preference dividend rate determined?
The preference dividend rate is usually stipulated when the preferred shares are issued and is based on a percentage of the face value of the shares. This rate generally remains fixed unless specified otherwise.
What happens if a company cannot pay preference dividends?
For cumulative preference shares, any unpaid dividends accumulate and must be paid out before any ordinary dividends can be distributed. For non-cumulative preference shares, unpaid dividends from prior years do not carry forward.
Are preference dividends guaranteed?
While they have a higher claim to dividends than common shares, preference dividends are not guaranteed and depend on the company’s financial health and ability to pay dividends.
Can the rate of preference dividends change?
Typically, the rate of preference dividends is fixed. However, some preferred shares may have provisions for changes in the rate based on certain conditions outlined by the issuer.
Related Terms
-
Ordinary Shares: Equity shares that represent ownership in a company and typically come with voting rights. Dividends on ordinary shares are paid out after preference dividends.
-
Cumulative Preference Shares: A type of preferred stock where unpaid dividends accumulate and must be paid before common shareholders receive any dividends.
-
Non-Cumulative Preference Shares: Preferred shares where missed dividend payments do not accumulate.
-
Dividend Yield: A financial ratio that shows how much a company pays out in dividends each year relative to its share price.
Online References
- Investopedia - Preferred Dividend
- The Balance - What Are Preferred Shares?
- Accounting Tools - Preference Shares
Suggested Books for Further Studies
- “Accounting for Investments, Equities, Futures, and Options” by R. Venkata Subramani
- “Financial Accounting Theory” by William Scott
- “Essentials of Financial Accounting in Business” by Mike Bendrey, Roger Hussey, and Colston West
Accounting Basics: “Preference Dividend” Fundamentals Quiz
Thank you for taking this quiz to deepen your understanding of preference dividends and related concepts. Continue exploring accounting and finance topics for a comprehensive grasp of the field.
