I need help with my financial accounting practice problems for a test. Here it goes:

Torres Wholesale Merchandise had 20,000 shares of 5%, $20 par value preferred stock and 15,000 shares of $25 par value common stock outstanding throughout 2011. These data apply to each of the independent situations below.

1. Assuming that total dividends declared in 2011 were $25,000 and that the preferred stock is noncumulative, common stockholders should receive total 2011 dividends of ...

2. Assuming that total dividends declared in 2011 were $80,000 and that the preferred stock is cumulative with two years; preferred dividends in arrears on December 31, 2010, the preferred stockholders should receive 2011 dividends totaling...

3. Assuming that total dividends declared in 2011 were $45,000 and that the cumulative preferred stock was issued on January 1, 2010, and that $10,000 of preferred dividends were declared and paid in 2010, the common stockholders should receive 2011 dividends totaling...

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The terms of the preferred stock will tell you how much the preferred shareholders should get. Why don't you compute that, show your work, and we'll see if you are on the right track.

It's not homework, it's practice problems for my upcoming final.

But here are my computations for what I have so far...

#1:

5% x 20 = 1
1 x 20,000 = 20,000

$25,000 - $20,000 = $5,000 -------> Is this correct?

#2:

80,000 x 2 = 160,000
160,000 + 80,000 = 240,000

#3: I'm clueless...

#1 is correct

When they say they are cumulative, that means that if the company can't pay the $20,000 in any year(s), when the dividends are declared the preferred shareholders get their dividends and back dividends first - before the common shareholders get anything. This also applies to partial dividends. If they receive part of the $20,000, the remaining part is due them prior to the common shareholders getting dividends.

So, for #2, how much do the preferred have coming for the current year and past 2 years.

I'm thinking if you understand #2, #3 may now make sense.

Sorry but the explanation is kind of confusing to me. The current year 2011 and I'm trying to find numbers for 2009 and 2010 as well?

Sorry but the explanation is kind of confusing to me. The current year 2011 and I'm trying to find numbers for 2009 and 2010 as well?

You have computed that the preferred shareholders are to receive $20,000 in dividends per year. Some years the company might not declare dividends. If that is the case, the dividends are in arrears. When dividends are declared, the arrears will be paid. So, if they did not declare dividends in 2009 or 2010, how much is in arrears? Add to that the dividends for the current year ($20,000), and how much in total will go to the preferred shareholders before the common shareholders partake in dividends?

Since $80,000 were paid in dividends in 2011, and $20,000 weren't paid in dividends in both 2009 and 2010, then $40,000 are in arrears? Therefore, they are paid $60,000?

Since $80,000 were paid in dividends in 2011, and $20,000 weren't paid in dividends in both 2009 and 2010, then $40,000 are in arrears? Therefore, they are paid $60,000??

Right. The preferred are due $20,000 for 2009 in arrears; $20,000 for 2010 in arrears; and $20,000 for 2011. That leaves $20,000 for the common shareholders.

Do you understand #3 now?

Oops, I meant $120,000

Comment on k3s0504's post

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oops, i meant $120,000

Sounds like some confusion here. Did you understand my last post, agreeing to your original answer? A total of $80,000 were declared. Preferred are entitled to the first $60,000 - leaving $20,000 for the common shareholders.

But for #2, the question states that $80,000 were declared in 2011. So the calculation, 80,000 - 20,000 (2009) - 20,000 (2010) - 20,000 (2011) = 60,000 is correct?

I don't understand where the 20,000 for 2011 came from.

When dividends are declared, dividends in arrears on cumulative preferred stock are paid first. $80,000 was declared in 2011. The order of the payment would be:

$20,000 for dividends in arrears for 2009 for Preferred
$20,000 for dividends in arrears for 2010 for Preferred
$20,000 for dividends for 2011 for Preferred

That totals $60,000. Since $80,000 was declared, that means there is still $20,000 remaining. This is the amount the common shareholders will split.

#3:

$45,000 - $10,000 - $20,000 = $15,000?

#3:

$45,000 - $10,000 - $20,000 = $15,000?

Yes, that's right.

Does it all make sense now?

O OK. So therefore, since its cumulative, the preferred stockholders should receive $60,000 in 2011.

Yes it does! Thanks so much!

Right.

When you read these questions, first make sure it's a cumulative preferred stock. Not all of them are. Then, look to see if there are dividends in arrears. The oldest arrears are paid first. Only if money is left over are the current year dividends paid - and then it goes first to the Preferred. Common shareholders only get something if the Preferred are completely satisfied.

So if I have a similar question to number two except that the total dividends declared in 2011 were $35,000, what would change? Since we're only looking for the preferred stockholders' 2011 total dividends. Would it still be $60,000? Or since it's less that $35,000, we do something different?

Are you saying that the following exists:

20,000 shares of 5%, $20 par value cumulative preferred stock
2 years in arrears
$35,000 is declared

Remember arrears are always paid first. Show me what you think the order of payment would be.

I thought that arrears were always $20,000.

Also, we haven't touched the information "15,000 shares of $25 par value common stock outstanding throughout 2011."

The difference with preferred and common stock when it comes to dividends is that preferred stock will only get what they are entitled to - which is based on the shares, par value and %. Common shareholders could get anything - it has nothing to do with par value or number of shares. The preferred shareholders are paid first. Once you determine how much they have coming, anything left over goes to the common. We did deal with the common shareholders in that we determined that the preferred had $60,000 coming and therefore the remaining $20,000 went to the common shareholders. There was nothing else to calculate for the common - they get the balance after the preferred are satisfied.

I'm not sure exactly what you mean by the preferred always get $20,000 a year. In your example of 20,000 shares of 5%, $20 par value cumulative preferred stock, they get $20,000 per year. (5% x 20,000 x 20) If for example, you had 10,000 shares of 4%, $10 par value cumulative preferred stock, the calculation would be different: 4% x 10,000 x 10 = 4,000 In this case, if the preferred were in arrears for 2 years, they would be in arrears $8,000.

Ok so in the new case where the following apply:

20,000 shares of 5%, $20 par value cumulative preferred stock
2 years in arrears
$35,000 is declared

The firs two years in arrears need to be paid first, which is 40,000. Isn't there still 20,000 for 2011? And aren't preferred stockholders' entitled to the arrears? Not sure what to do with the $35,000...

They will only pay out what is declared. They will pay out $35,000. Since there is $40,000 in arrears, the $35,000 is paid to the preferred shareholders reducing that $40,000 to $5,000 in arrears for 2009 and 2010. They will then also be in arrears of $20,000 for 2011.

Therefore, there is $5,000 for 2009 and 2010 combined in arrears + the 20,000 for 2011. So, preferred stockholders are due 25,000 in 2011 for dividends?

Let me restate this just to be sure you understand.

The $35,000 in dividends declared will all go the to preferred shareholders because their arrears are in excess of $35,000.

At that point, they are now still $5,000 in arrears for 2009 and 2010. If no other dividends are declared in 2011, they will then be in arrears an additional $20,000 for 2011. This $25,000 would have to be satisfied before the common shareholders would get anything.

If in your post, you meant preferred shareholders are then $25,000 in arrears - that is correct. I'm just making sure you understand how the declared $35,000 is distributed.