When a corporation has dividends in arrears on its cumulative preferred stock, it must first pay the past omitted preferred dividends and then the current year's preferred dividends before it can pay its common stockholders any dividends.

For example, if a corporation has cumulative preferred stock with an annual dividend of $10,000 and it has omitted the dividends for the past three years, there is $30,000 of dividends in arrears. In order to pay any dividend to its common stockholders, the corporation will have to first pay its preferred stockholders $40,000. That is the amount of the past omitted dividends of $30,000 and the current year preferred dividend of $10,000.

Using the information above, but assuming that the corporation pays a total of only $5,000 in dividends in the current year, the preferred stockholders must receive the entire $5,000 and the dividends in arrears will be $35,000 at the end of the current year.

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