Question

Assuming that the company has retained earnings of "$86,000", 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.

Answer 1

Answer:

a. preferred stock=$32000  ,  ordinary stock=$54000

b. preferred stock=$16000  ,   ordinary stock=$70000

Explanation:

Lets assume the company has two class of preferred stock, cumulative and non-cumulative. Cumulative preferred stock are shares whose fixed return (i.e fixed dividend) if not paid in one accounting period accumulates with forthcoming years' return and is paid in accumulation whereas non-cumulative preferred stock holders won't be paid for dividends not paid in a year.

Lets assume, Company has 2000 $100 par value 8% preferred stock and 5100 $50 par value ordinary shares.

1st case: CPS (Cumulative preferred stock) and OS (Ordinary stock.)

$86000 of retained earnings will be distributed as follows:

Preferred Stock dividend each year: 2000×$100×0.08

PS dividend=$16000 per year

Now accumulate for 2 years,

CPS dividend = $16000×2

CPS dividend = $32000

After preferred stock holders are paid, the remaining retained earnings are wholly distributed to ordinary stock holders.

Ordinary stock dividend = $86000 - $32000

Ordinary stock dividend = $54000.

2nd case: NCPS (Non-cumulative preferred stock) and OS (Ordinary stock).

$86000 of retained earnings will be distributed as follows:

NCPS dividend for the current year only = 2000×$100×0.08

NCPS dividend for the current year only = $16000

Now, the remaining is distributed to ordinary stock holders as follows:

Ordinary stock dividend = $86000 - $16000

Ordinary stock dividend = $70000