Question

(Preferred Dividends) The outstanding capital stock of Edna Millay Corporation consists of 2,000 shares of \(100 par value, 8% preferred, and 5,000 shares of \)50 par value common.

Instructions

Assuming that the company has retained earnings of $90,000, all of which is to be paid out in dividends, and that preferred dividends were not paid during the 2 years preceding the current year, state how much each class of stock should receive under each of the following conditions.

1. The preferred stock is noncumulative and nonparticipating.
2. The preferred stock is cumulative and nonparticipating.
3. The preferred stock is cumulative and participating. (Round dividend rate percentages to four decimal places.)

Short answer

	Preferred	Common
Noncumulative and nonparticipating	$16,000	$74,000
Cumulative and nonparticipating	$48,000	$42,000
Cumulative and participating	$57,778	$32,222

Step-by-step solution

Meaning of Preferred Dividends

The preferred dividend is a cash distribution made to preferred shareholders by a company. The preferred shareholders receive, on an annual basis, a percentage of the retained earnings of the company.

Classifying stock when it is noncumulative and nonparticipating

S.no.		Preferred	Common	Total
(a)	Preferred stock is noncumulative, nonparticipating	$16,000
	Remainder $\left(\$90,000-\$16,000\right)$		$74,000	$90,000

Calculating the amount of Preferred stock

$\begin{array}{rcl}\mathbf{Preferred}\mathbf{}\mathbf{stock}\mathbf{}\mathbf{amount}& \mathbf{=}& \mathbf{Shares}\mathbf{\times }\mathbf{Par}\mathbf{}\mathbf{value}\mathbf{\times }\mathbf{Preferred}\\ & \mathbf{=}& \mathbf{2}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{\$}\mathbf{100}\mathbf{\times }\mathbf{8}\mathbf{\%}\\ & \mathbf{=}& \mathbf{\$}\mathbf{16}\mathbf{,}\mathbf{000}\end{array}$

Classifying stock when it is cumulative and nonparticipating

S.no.		Preferred	Common	Total
(b)	Preferred stock is cumulative, nonparticipating $\left(\$16,000\times 3\right)$	$48,000
	Remainder $\left(\$90,000-\$42,000\right)$		$42,000	$90,000

Determining stock when it is cumulative and participating

S.no.		Preferred	Common	Total
(c)	Preferred stock is cumulative, participating	$57,778	$32,222	$90,000

The computation for these amounts is as follows:

S.no.		Preferred	Common	Total
	Dividend in arrears $\left(2\times \$16,000\right)$	$32,000		$32,000
	Current Dividend	16,000		16,000
	Pro-rata shares to common $\left(5,000\times \$50\times 8\%\right)$		$20,000	20,000
	Balance divided pro-rata	9,778	12,222	22,000
		$57,778	$32,222	$90,000

Computing the participating amount

The additional amount available for participation $\left(\$90,000-\$32,000-\$16,000-\$20,000\right)$	22,000
Par value of stock that is to participate Preferred $\left(2,000\times \$100\right)$$200,000 Common $\left(5,000\times \$50\right)$250,000	450,000
Rate of participating dividend $\left(\$22,000÷\$450,000\right)$	4.8889%
Participating dividend Preferred,$\left(4.889\%\times \$200,000\right)$ Common, $\left(4.889\%\times \$250,000\right)$	$9,778 12,222
	$22,000