Question

(Preferred Dividends) Matt Schmidt Company’s ledger shows the following balances on December 31, 2017.

7% Preferred stock—\(10 par value, outstanding 20,000 shares \) 200,000

Common stock—\(100 par value, outstanding 30,000 shares 3,000,000

Retained earnings 630,000

Instructions

Assuming that the directors decide to declare total dividends in the amount of \)366,000, determine how much each class of stock should receive under each of the conditions stated below. One year’s dividends are in arrears on the preferred stock.

1. The preferred stock is cumulative and fully participating.
2. The preferred stock is noncumulative and nonparticipating.
3. The preferred stock is noncumulative and is participating in distributions in excess of a 10% dividend rate on the common stock.

Short answer

	Preferred	Common
Cumulative and participating	$ 36,000	$ 330,000
Noncumulative and nonparticipating	$ 14,000	$ 352,000
Noncumulative and participating	$ 17,250	$ 348,750

Step-by-step solution

Meaning of Preferred Stock

A stock with more rights for getting fixed returns than common stock is called preferred stock. In the event of bankruptcy or a merger, preferred stockholders are paid first. Investors seeking a consistent dividend prefer common shares over preferred shares, which companies usually issue.

Classifying stock when it is cumulative and fully participating

S.no.		Preferred	Common	Total
(a)	Preferred stock is cumulative, fully participating	$36,000	$330,000	$366,000

The computation for these amounts is as follows:

S.no.		Preferred	Common	Total
	Dividend in arrears $\left(7\%\times \$10\times 20,000\right)$	$ 14,000		$ 14,000
	Current Dividend Preferred Common$\left(7\%\times \$100\times 30,000\right)$	14,000	$210,000	224,000
	Balance divided pro-rata	8,000	120,222	128,000
		$36,000	$330,000	$366,000

Computing the participating amount

The additional amount available for participation $\left(\$366,000-\$14,000-\$210,000\right)$	$ 128,000
Par value of stock that is to participate $\left(\$200,000+\$3,000,000\right)$	$3,200,000
Rate of participation$\left(\$128,000-\$3,200,000\right)$	4%
Participating dividend Preferred,$\left(4\%\times \$200,000\right)$ Common, role="math" localid="1648200099545" $\left(4\%\times \$3,000,000\right)$	$ 8,000 120,000
	$ 128,000

Classifying stock when it is noncumulative and nonparticipating

S.no.		Preferred	Common	Total
(b)	Preferred stock is noncumulative and nonparticipating	$ 14,000	$352,000	$366,000

The computation for the amounts is as follows:

S.no.
	Current dividend (preferred) $\left(7\%\times \$10\times 20,000\right)$	$ 14,000
	Remainder to Common $\left(\$366,000-\$14,000\right)$	352,000
		$366,000

Classifying stock when it is noncumulative and is participating

S.no.		Preferred	Common	Total
(c)	Preferred stock is noncumulative and participates in distributions in excess of 10%	$ 17,250	$ 348,750	$366,000

The computation for these amounts is as follows:

S.no.		Preferred	Common	Total
	Current year Preferred $\left(7\%\times \$10\times 20,000\right)$ Common $\left(7\%\times \$3,000,000\right)$	$ 14,000	$210,000	$ 14,000 $210,000
	Additional 3% to common $\left(3\%\times \$3,000,000\right)$		90,000	90,000
	Balance divided pro-rata	3,250	48,750	52,000
		$ 17,250	$ 348,750	$ 366,000

Computing the participating amount

The additional amount available for participation $\left(\$366,000-\$14,000-\$210,000-\$90,000\right)$	$ 52,000
Par value of stock that is to participate $\left(\$200,000+\$3,000,000\right)$	$3,200,000
Rate of participation$\left(\$52,000-\$3,200,000\right)$	1.625%
Participating dividend Preferred,$\left(1.625\%\times \$200,000\right)$ Common, $\left(1.625\%\times \$3,000,000\right)$	$ 3,250 48,750
	$ 52,000