|Jan 21||Retained earnings ($100,000 x 2% dividend)||2,000|
|Declared 2% cash dividend to payable Mar 1 to shareholders of record Feb 5.|
|Mar 1||Dividends payable||2,000|
|Paid the dividend declared on January 21.|
Usually, stockholders receive dividends on preferred stock quarterly. Such dividends—in full or in part—must be declared by the board of directors before paid. In some states, corporations can declare preferred stock dividends only if they have retained earnings (income that has been retained in the business) at least equal to the dividend declared.
Noncumulative preferred stock is preferred stock on which the right to receive a dividend expires whenever the dividend is not declared. When noncumulative preferred stock is outstanding, a dividend omitted or not paid in any one year need not be paid in any future year. Because omitted dividends are lost forever, noncumulative preferred stocks are not attractive to investors and are rarely issued.
Cumulative preferred stock is preferred stock for which the right to receive a basic dividend accumulates if the dividend is not paid. Companies must pay unpaid cumulative preferred dividends before paying any dividends on the common stock.
For example, assume a company has 10,00 shares of cumulative $10 par value, 10% preferred stock outstanding, common stock outstanding of $200,000, and retained earnings of $30,000. The company did not pay dividends last year. The company would pay the preferred stockholders dividends of $20,000 (10,000 shares preferred stock x $10 par value x 10% dividend rate = $10,000 per year x 2 years) before paying any dividends to the common stockholders. If the board declares dividends of $25,000, $20,000 would be paid to preferred and the remaining $5,000 ($25,0000 dividends - $20,000 paid to preferred) would be shared by common stockholders. Common stockholders are not guaranteed dividends and will receie only the amount left over after paying preferred stock holders. Keep in mind, you can never pay out more in dividends than you have declared!
Dividends in arrears are cumulative unpaid dividends, including the dividends not declared for the current year. Dividends in arrears never appear as a liability of the corporation because they are not a legal liability until declared by the board of directors. However, since the amount of dividends in arrears may influence the decisions of users of a corporation’s financial statements, firms disclose such dividends in a footnote. An appropriate footnote might read: “Dividends in the amount of $20,000, representing two years’ dividends on the company’s 10%, cumulative preferred stock, were in arrears as of December 31″.
The board of directors of a corporation possesses sole power to declare dividends. The legality of a dividend generally depends on the amount of retained earnings available for dividends—not on the net income of any one period. Firms can pay dividends in periods in which they incurred losses, provided retained earnings and the cash position justify the dividend. And in some states, companies can declare dividends from current earnings despite an accumulated deficit. The financial advisability of declaring a dividend depends on the cash position of the corporation.
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