What are Dividends in Arrears?

A dividend in arrears is a dividend payment associated with cumulative preferred stock that has not been paid by the expected date. These dividends have not been authorized by the board of directors, because the issuing entity does not have sufficient cash to make the payment.

Dividends in arrears may pile up over several subsequent payment dates, if the financial circumstances of a business do not allow for these payments. During this time, the market price of the associated preferred stock is likely to plummet, since the dividend payments represent the main source of value for preferred shareholders.

If the situation ever improves, the board of directors will then authorize that a portion or all of these dividends be paid. Once the authorization is made, these dividends appear in the balance sheet of the issuing entity as a short-term liability. When paid, dividends in arrears go to the current holder of the related preferred stock. No payments are made to the person or entity that held the stock at the time when the dividends were in arrears. Instead, only the new holders benefit from these payments.

The existence of any dividends in arrears is a concern to common stockholders, since they cannot receive any dividends until the full amount of the dividends in arrears has been paid to the preferred stockholders. This can effectively eliminate all dividends to common stockholders for an extended period of time.

How to Calculate Dividends in Arrears

The annual amount of a dividend that is supposed to be paid is located in the prospectus that was produced by the issuer of preferred stock. This information is stated in the offering summary section of the prospectus. Multiply this amount by the total number of preferred shares issued by the company, to arrive at the total amount of the dividend that should be paid each year. This dividend is usually paid quarterly, so divide it by four to arrive at the expected quarterly payment. Then multiply this amount by the number of dividend payments that the issuer missed. This outcome is the amount that the issuer is required to pay before any dividends can be paid to the holders of its common stock.

Disclosure of Dividends in Arrears

The existence of dividends in arrears is disclosed in the footnotes that accompany the financial statements. Investors will want to see this information, since it impacts their decision to invest in a business.