Dividends in Arrears in Cumulative Preferred Stocks (Definition)

What are Dividends in Arrears?

Dividend in arrears is nothing but the cumulative amount of dividend which has not paid on an expected date to cumulative preferred stockholders because of various 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 shareholders are the owner of the company, they have voting rights and 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 make the dividend payment in that case dividend of cumulative preference shareholders will accumulate and will be paid in the future when the company will declare the dividend.
Non Cumulative Preference Share: Non-cumulative preference shares have the same features which are available to cumulative preference share except one which is an accumulation of dividend suppose company will not able to make payment of dividend in any year then they can’t claim unpaid dividend in future.

Features of Dividend in Arrears

Some of the features are as below:

This is applicable on cumulative preference shares.
It is paid before making payment to common shareholders or noncumulative preference shareholders.
There is no maximum time limit for accumulation; it can be accumulated for any no. of years.
The company does not require making the payment of these dividends unless the dividend declared 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 sheet.
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 stock

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You can download this Dividends in Arrears Excel Template here – Dividends in Arrears Excel Template

ABC Inc has issued 10,000 ordinary shares and 1000 cumulative preference share and cumulative preferred shareholder will receive guaranteed $ 5 per share each year as a dividend, these shares have been issued on 1^st Jan’2015. As on 31^st Dec’15 Company does not have sufficient cash balance for making the payment to its preference shareholder therefore total dividend amount on cumulative preference shares will remain unpaid and will treat as a dividend in arrears.

Solution:

Calculation of dividend in arrears on 31^st Dec’18 will be –

Dividend in Arrears as on 31^st Dec’18 = Total No. of Cumulative Preference Shares Issued * Dividend
Dividend in Arrears as On 31^st 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 31^st 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

ABC Inc will pay only $ 10,000, therefore, first arrears of the year 2015 and 2016 will be paid 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 for raising funds and it is a very attractive financial instrument because it 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 but 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.