Dividends In Arrears Meaning Features Examples

Dividends in Arrears Meaning

A dividend in arrears is nothing but the cumulative amount of dividend, unpaid on an expected date to a cumulative preferred stockholder. It can happen because the company may not have sufficient cash balance to pay dividends.

Important Terms

To understand 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 company’s owners. They have voting rights. They get the dividend only after paying dividends to preferred shareholders.Cumulative Preference Shares: Cumulative preference shareholders receive the fixed dividend rate, and they have a preference over ordinary shares. But they do not 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 delivered in the future when the company declares 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 as cumulative preference shares, except for an accumulation of dividends. Suppose the company cannot make payment of dividends in any year, then they cannot claim unpaid dividends in the future.

Features of Dividend in Arrears

Some of the features are as below:

It applies to cumulative preference shares.Paid before making payment to common shareholders or non-cumulative preference shareholders.There is no maximum time limit for accumulation. It can accumulate for any number of years.The company does not require paying 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 be considered in accounts.It needs to disclose under notes to accounts on 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 is not required to pay any claim for the unpaid period.

Example of Dividends in Arrears

Let us understand this with the below example of dividends in arrears on 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 10000 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 were issued on January 1, 2015. As of December 31, 2015, the company does not have a sufficient cash balance to make the payment to its preferred shareholder. Therefore the total dividend amount on cumulative preference shares remains unpaid and will be treated as a dividend in arrears. How? Let us find out:

Solution:

Calculation of dividend in arrears on December 31, 2018, will be –

Dividend in Arrears as of December 31, 2018, = Total No. of Cumulative Preference Shares Issued * Dividend.Dividend in Arrears as on December 31, 2018 = 1000 * $5 = $5,000Second and third-year also, ABC Inc cannot pay dividends because of the unavailability of cash balance. Therefore, the total unpaid dividend on December 31, 2017, will be $15,000.Now, the company does good business in the fourth year and has sufficient cash balance to make the dividend as follows:

Case #1

ABC Inc will pay a total dividend of $40,000 to its shareholders in the 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 share * No. of YearsTotal dividend in arrear = 1000 * $5 * 4 = $20,000After paying a cumulative preference shareholder balance of $20,000, the company will pay to a common shareholder $2 per share.

Case #2

ABC Inc will pay a total dividend of $20,000 to its shareholders in the below manner:The dividend will be first payable to cumulative preference shareholders with the arrears of dividends.Total dividend in arrear = 1000 * $5 * 4 = $20,000There is nothing in balance, so common shareholders will not get dividends.

Case #3

ABC Inc will pay a total dividend of $10,000 to its shareholders in the below manner:

The dividend will be first payable to cumulative preference shareholders with the arrears of dividends.Total dividend in arrear = 1000 * $5 *4 = $20,000
ABC Inc will pay only $10,000. Therefore, it delivers the first arrears of 2015 and 2016, and 2017 and 2018 will remain as it is.Since no balance is left, ordinary shareholders will not receive any dividends.

Conclusion

Dividends in arrears are a cumulative amount of unpaid dividends of past years payable on cumulative preference shares only. Cumulative preference share helps the company raise funds, and it is a financial instrument because it carries the nature of equity and debt.

It benefits the investors because they will get a fixed dividend and preference over ordinary shareholders. Sometimes it will be delayed if the company does not have sufficient cash, and they will also not get any interest in the delayed payment of dividends.

At the same time, it is beneficial for the company that does not require to pay every year compulsorily. It can be paid in the latter year with the arrear of the past year without any interest.