How are dividends paid when there are dividends in arrears?

Definition of Dividends in Arrears

Dividends in arrears exist when a corporation has:

• Cumulative preferred stock
• Omitted past dividends on the cumulative preferred stock and the amount has not yet been paid

If the corporation wants to pay any dividends to its common and preferred stockholders, it must do the following:

1. Pay any dividends in arrears
2. Pay the preferred stock's current year dividend
3. Pay a dividend to the holders of the corporation's common stock

Example of Paying Dividends in Arrears

Assume that a corporation has cumulative preferred stock with an annual dividend of $10,000 and it has omitted the dividends for the past three years. Therefore, there are $30,000 of dividends in arrears. The corporation decides to pay dividends of $60,000. The dividends will be paid as follows:

1. Pay $30,000 to preferred stockholders for the dividends in arrears
2. Pay the preferred stock's current year dividend of $10,000
3. Pay $20,000 to the common stockholders

Now let's assume that the corporation decides to pay dividends of $25,000 (instead of $60,000). The entire $25,000 must be paid to the preferred stockholders and the dividends in arrears will be $15,000 at the end of the current year. (The $15,000 = the remaining $5,000 of dividends in arrears + the $10,000 current year preferred dividend that is being omitted.)