Cumulative preferred stock is a class of preferred stock whose stated dividend does not disappear when the board declines to declare it. Every period the dividend is passed accumulates as an arrearage, also called a dividend in arrears, and that whole accumulation plus the current period’s preference has to be paid or set apart before any dividend can reach common stock. On a noncumulative class the passed dividend simply lapses and is never made up.
The word cumulative describes what happens to a missed dividend and nothing else. It settles no question about voting, redemption, conversion or liquidation, and what the label preferred settles on its own is in preferred stock.
Cumulation Is Drafted, Not Assumed
In Delaware, whether a class is cumulative is a term the certificate of incorporation or the issuing resolution has to state, and the label preferred does not supply it. Holders of preferred or special stock are entitled to receive dividends at such rates, on such conditions and at such times as shall be stated in the certificate of incorporation or in the resolution or resolutions providing for the issue of such stock adopted by the board of directors, and cumulative or noncumulative as shall be so stated and expressed (8 Del. C. § 151(c)).
Read that as an instruction about where the answer lives. The rate, the base the rate applies to, the times the dividend is payable, and whether an unpaid one accumulates are terms of a document rather than features of the class. For a firm, that makes the arrearage a document-reading job before it is a computation. The certificate of incorporation and the issuing resolution supply every input, and the trial balance supplies none of them. Whether the class also shares in the remainder after taking its preference is a separate axis, set out in participating preferred stock.
How Arrears Are Computed
The catch-up is the shortfall on the stated preference for every period the board has not declared it in full, and it sits in front of the current period’s preference. Say a corporation has one class of cumulative preferred stock whose certificate states the dividend as a rate on par value, the nominal amount per share fixed in the charter and set out in common stock. The board passes that dividend for three consecutive years and declares a total dividend in the fourth.
Preferred shares outstanding 5,000
Par value per share 100
Stated dividend rate 6%
Years the board passed the dividend 3
Annual preference 5,000 x 100 x 6% = 30,000
Arrearage 30,000 x 3 = 90,000
per preferred share 90,000 / 5,000 = 18
Year four preference = 30,000
Clearing before common 90,000 + 30,000 = 120,000
Total dividend declared in year four 150,000
Reaching common 150,000 - 120,000 = 30,000Only three things move that answer: the stated preference, the amount left undeclared across the earlier periods, and the size of the declaration. Where the certificate states a fixed amount per share instead of a rate on par, the same catch-up runs off that amount. A noncumulative class on identical facts would enter the fourth year owing the current preference alone, and every dollar of the earlier accumulation would be gone.
Cumulative vs Noncumulative Preferred Stock
What separates the two is whether a period the board skips leaves a claim on a later declaration. Cumulative leaves one, noncumulative does not.
Neither class makes a dividend mandatory. The power to declare stays with the board, and an accumulated but undeclared amount is disclosed rather than recorded as a liability, which is worked through in preferred stock and, on the entry side, in dividend payable account.
Where a US Firm Meets a Cumulative Class
Two things follow from cumulation, and neither of them is a journal entry. The first is a disclosure. An entity discloses the aggregate and per-share amounts of arrearages in cumulative preferred dividends (FASB Statement No. 129, paragraph 7). The example above produces both of them, the accumulated total and that total divided by the shares outstanding, and a schedule carrying only the total is short one of the two required figures.
The second is the per-share line, and it arises only where the entity presents earnings per share at all. Where it does, the period’s accumulation is deducted from earnings before the per-share figure is computed, whether or not a dividend was declared, and earnings per share works that through.
Nothing else about the class turns on cumulation. Its balance sheet classification, its place on the corporate return, and the one-class-of-stock trap any preference springs on an S corporation client are answered in preferred stock.
Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a trial task lets a firm grade a real block of its own equity schedule work before a client filing depends on it.
