Dividends on Preferred Stock

The amount of the dividend for a preferred share is a specific, stated percentage of its par value.

As with common dividends, preferred dividends do not need to be paid each year. The company decides when they will pay dividends.

The dividend on a preferred share is either cumulative or non-cumulative. Whether it is cumulative or non-cumulative is determined by the company when the shares are issued and is not able to be changed by the company or the shareholder. The difference between cumulative and non-cumulative dividends is in what happens when a dividend is not declared in a given year.

Cumulative preferred shares

Cumulative preferred shares EARN their dividend every year, even if it is not paid in a specific year. If an earned cumulative dividend is not declared on cumulative preferred stock in a particular year, that dividend accumulates and it must be declared and paid in the future before any future common dividends may be paid. For shareholders, this means that even when a preferred, cumulative dividend is not paid in a specific year, it will most likely be paid in the future because until the accumulated preferred dividends (called dividends in arrears) have been paid, the company may not pay any common dividends.

Note: Dividends in arrears are not recorded as a liability on the balance sheet, but they are disclosed in a note to the financial statements. This disclosure is necessary so that a prospective buyer of the common shares can know whether or not the company will be able to pay dividends on its common stock in the future. If there are large cumulative dividends in arrears it will indicate that the company will not be able to pay common dividends until those preferred dividends in arrears are paid.

Non cumulative preferred shares

• If the preferred stock’s dividends are noncumulative, any dividend that is not declared in a specific year is lost and will not be collectible by shareholders in future periods.