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The records of Hoffman Company reflected the following balances in the shareholder's equity accounts at December 31, 2011:

Common Shares, par $12 per share, 40,000 shares outstanding. Preferred shares, 8%, par $10 per share, 6,000 shares outstanding. Retained earnings, $220,000.

On January 1, 2012, the board of directors was considering the distribution of a $62,000 cash dividend. No dividends were paid during 2010 and 2011.

1.) Determine the total and per share amounts that would be paid to the common shareholders and to the preferred shareholders under two independent assumptions.
a. The preferred shares are non cumulative.
b. The preferred shares are cumulative.
2.) Explain why they were less for the second assumption.
3.) What factors would cause a more favourable dividend for the stock holder's?

Cumulative preferred stock accumulate dividends regardless if they are declared or not. They are automatically entitled to a dividend and continue to accrue a dividend until paid. The right to receive the annual dividend accumulates year after year until paid.

Common stock and noncumulative preferred dividends cannot be paid until the cumulative dividends are paid in full including any arrears. In the problem 8% of par value $60,000 would be cumulative each year, or $4,800 per year.

If the preferred dividends were not paid for ten years, then the cumulative balance of entitlement is $48,000 which must be paid before any dividends could be paid to noncumulative preferred stock and then common stock in that order.

Noncumulative preferred stock are like common stock. They are not entitled to a dividend unless declared by the Board of Directors.



Under condition a. $4,800 would be paid to noncumulative preferred stock leaving $57,200 to be distributed to 40,000 common shares or $1.43 per share.


Under condition b. two years of dividends are due to cumulative preferred stock or $9,600 leaving $52,400 to be distributed to 40,000 shares or $1.31 per share.


2. Dividends paid to stockholders are less because cumulative preferred shares reduce dividends available to stockholders, moreover if there are any accumulated dividends from prior years, then dividends available to stockholders are reduced further.

3. The absence of preferred shares would result in more favorable dividends. In addition, abundant company profitability would result in more favorable dividends in spite of the presence of preferred shares.

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