Introduction:

Dividend in arrears refers to the accumulated, unpaid dividends on cumulative preferred stock that have not been distributed to shareholders by the issuing company. Cumulative preferred stockholders have a contractual right to receive dividends before common stockholders.

However, if the company faces financial difficulties and cannot pay the full dividends owed to preferred stockholders in a particular period, the unpaid dividends accumulate and become dividends in arrears.

Understanding Dividend in Arrears:

1. Cumulative Preferred Stock: Cumulative preferred stock is a type of preferred stock that entitles its holders to receive unpaid dividends from previous periods before common stockholders can receive any dividends. This means that if the company skips or reduces dividends in any year, it must make up for those unpaid dividends in the future before paying dividends to common stockholders.

2. Accumulation of Unpaid Dividends: Dividends in arrears occur when the company fails to pay the full amount of dividends owed to cumulative preferred stockholders. The unpaid dividends from previous years accumulate as dividends in arrears until the company is financially capable of fulfilling its obligation.

3. Payment Priority: When a company decides to pay dividends, it must first clear any accumulated dividends in arrears before paying dividends to common stockholders or dividends on non-cumulative preferred stock.

4. Impact on Shareholders: Dividends in arrears represent a liability for the company and an asset for the preferred shareholders. Shareholders with dividends in arrears have a claim on those unpaid dividends and are entitled to receive them before any new dividends can be distributed.

Calculation of Dividend in Arrears:

The calculation of dividends in arrears is relatively straightforward. To determine the amount of unpaid dividends, one must multiply the annual dividend rate for each share of cumulative preferred stock by the number of years the dividends have been skipped or reduced.

Example: Suppose a company issues cumulative preferred stock with an annual dividend rate of $2 per share. The company skipped paying dividends for three years.

Dividend in Arrears = $2 (annual dividend rate) x 3 (years) = $6 per share

In this example, the dividends in arrears would be $6 per share of cumulative preferred stock.

Resolution of Dividends in Arrears:

Companies aim to resolve dividends in arrears as soon as they are financially capable. Once the company resumes paying dividends to preferred stockholders, it must first clear the accumulated dividends in arrears before distributing any new dividends.

Conclusion:

Dividend in arrears is a concept specific to cumulative preferred stock, where unpaid dividends from previous periods accumulate until the company can fulfill its obligation. It represents a contractual right for preferred stockholders and a financial liability for the company.

Companies strive to address dividends in arrears when they are financially stable, prioritizing the payment to preferred stockholders before distributing any new dividends. Investors in cumulative preferred stock should be aware of this feature, as it can impact their overall return on investment and dividend income.