What are Dividends in Arrears?
Dividend in arrears is nothing but the cumulative amount of dividend, unpaid on an expected date to a cumulative preferred stockholder. It can happen due to reasons like the company may not have sufficient cash balance to make the payment of dividends.
Important Terms
For understanding the dividend in arrears, we need to know about the below terms first:
- Ordinary Shares/Equity Shares: Ordinary shareholdersOrdinary ShareholdersOrdinary Shares are the shares that are issued by the company for the purpose of raising the funds from the public and the private sources for its working. Such shares carry voting rights and are shown under owner’s equity in the liability side of the balance sheet of the company.read more are the owner of the company. They have voting rights. They get the dividend only after making the payment of dividends to preference shareholders.
- Cumulative Preference Shares: Cumulative preference shareholders receive the fixed rate of dividend, and they have preference over ordinary shares. But they don’t have voting rights. If the company does not have sufficient cash to pay the dividend, the dividend of cumulative preference shareholders will accumulate. It will be paid in the future when the company will declare the dividend.
- Non Cumulative Preference Share: Non-cumulative preference sharesNon-cumulative Preference SharesNon-cumulative preference shares are the stocks which allow the investors to receive a fixed dividend at the pre-determined dividend rate every year. However, if any year's dividend remains unpaid, the preference shareholders are not liable to receive it in the future.read more have the same features which are available to cumulative preference share except one an accumulation of dividend. Suppose the company is unable to make payment of dividends in any year, then they can’t claim unpaid dividends in the future.
Features of Dividend in Arrears
Some of the features are as below:
- It is applicable on cumulative preference shares.
- Paid before making payment to common shareholders or non-cumulative preference shareholders;
- There is no maximum time limit for accumulation, can accumulate for any number of years.
- The company does not require making the payment of these dividends unless the dividend declaredDividend DeclaredDividend declared is that portion of profits earned that the company’s board of directors decides to pay off as dividends to the shareholders of such company in return to the investment done by the shareholders through the purchase of the company’s securities.read more in the future.
- Dividends in arrears are not the actual liabilities; therefore, it does not need to consider this in accounts.
- It needs to disclose under notes to accounts of the balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more.
- It does not carry any interest in the arrear period. Thus the company does not require to pay any interest for the unpaid period.
Example of Dividends in Arrears
Let’s understand this with the below example of dividends in arrears in cumulative preferred stockCumulative Preferred StockCumulative preferred stock is a class of shares wherein any current year's unpaid or undeclared dividends must be accumulated and paid in the future. However, such stocks are costlier, do not have voting rights and cannot demand the interim dividends.read more
ABC Inc issued 10,000 ordinary shares and 1000 cumulative preference shares. A cumulative preferred shareholder will receive a guaranteed $ 5 per share each year as a dividend. These shares are issued on 1st Jan’2015. As on 31st Dec’15 Company does not have sufficient cash balance for making the payment to its preference shareholder. Therefore the total dividend amount on cumulative preference shares remains unpaid and will treat as a dividend in arrears.
Solution:
Calculation of dividend in arrears on 31st Dec’18 will be –
- Dividend in Arrears as on 31st Dec’18 = Total No. of Cumulative Preference Shares Issued * Dividend
- Dividend in Arrears as On 31st Dec’18 = 1000 * $ 5 = $ 5000
- Second and third-year also, ABC Inc is not able to make the payment of dividends because of the unavailability of cash balance; therefore total unpaid dividend as on 31st Dec’17 will be $ 15000.
- Now on the fourth-year company has does good business and company have sufficient cash balance to make the dividend as follows:
Case #1
- ABC Inc will pay a total dividend of $ 40000 to its shareholders in below manner:
- The dividend will be first payable to cumulative preference shareholders with the arrears of dividends.
Calculation of Total Dividend in Arrear will be –
- Total Dividend in Arrear = No. of Shares * Dividend per Shares* No. of Year
- Total Dividend in Arrear = 1000 * $5 * 4 = $ 20000
- After making payment to a cumulative preference shareholder balance of $ 20,000 will pay to a common shareholder, which is $ 2 per share.
Case #2
- ABC Inc will pay a total dividend of $ 20000 to its shareholders in below manner:
- The dividend will be first payable to cumulative preference shareholders with the arrears of dividends.
- Total Dividend in Arrear = 1000 * $5 * 4 = $ 20000
- Now there is nothing in balance; therefore, common shareholders will not get any dividend.
Case #3
- ABC Inc will pay a total dividend of $ 10000 to its shareholders in below manner:
- The dividend will be first payable to cumulative preference shareholders with the arrears of dividends.
- Total Dividend in Arrear = 1000 * $5 *4 = $ 20000
| Arrear Years | Amount |
|---|---|
| 2015 | $5,000 |
| 2016 | $5,000 |
| 2017 | $5,000 |
| 2018 | $5,000 |
- ABC Inc will pay only $ 10,000. Therefore, it pays the first arrears of the year 2015 and 2016, and 2017 and 2018 will remain as it is.
- Since there is no balance left; therefore, ordinary shareholders will not receive any dividend.
Conclusion
Dividends in arrears is a cumulative amount of unpaid dividends of past years payable on cumulative preference shares only. Cumulative preference share helps the company to raise funds, and it is a very attractive financial instrument because it is carrying the nature of equity and debt both.
It is beneficial for the investors because they will get a fixed rate of dividend and preference over ordinary shareholders. Still, sometimes it will be delayed if the company does not have a sufficient amount of cash, and they will also not get any interest in delay payment of dividends.
At the same time, it is beneficial for the company that the company needs not require to compulsorily require to pay every year. It can be paid in the latter year also with the arrear of the past year without any interest.
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