Financial Accounting: An Integrated Statements Approach, 2nd Edition

Preferred Stock

To appeal to a broader investment market, a corporation may issue one or more classes of

stock with various preference rights. A common example of such a right is the preference

to dividends. Such a stock is generally called a preferred stock. Similar to common stock,

preferred stock trades in the secondary markets, such as the New York Stock Exchange.

The dividend rights of preferred stock are usually stated in monetary terms or as a

percent of par. For example, $4 preferred stockhas a right to an annual $4 per share div-

idend. If the par value of the preferred stock was $50, the same right to dividends could

be stated as 8% ($4/$50) preferred stock.

A corporation cannot guarantee dividends, even to preferred

stockholders. However, because they have first rights to any div-

idends, the preferred stockholders have a greater chance of re-

ceiving regular dividends than do the common stockholders.

Cumulative preferred stockhas a right to receive regular

dividends that have been passed (not declared) before any com-

mon stock dividends are paid. Noncumulative preferred stock

does not have this right. Dividends that have been passed are

said to be in arrears. Such dividends should be disclosed, nor-

mally in a footnote to the financial statements.

To illustrate how dividends on cumulative preferred stock are calculated, assume

that a corporation has 1,000 shares of $4 cumulative preferred stock and 4,000 shares of

common stock outstanding, and that no dividends were paid in 2006 and 2007. In 2008,

the board of directors declares dividends of $22,000. Exhibit 3 shows how the dividends

paid in 2008 are distributed between the preferred and common stockholders.

498 Chapter 11 Stockholders’ Equity: Capital Stock and Dividends

PREFERRED

STOCK DIVIDENDS

DIVIDENDS

PAID IN 2008

2006

2007

2008

Exhibit 3

Dividends to Cumulative

Preferred Stock

What’s the Real Value?

Stock fraud often involves illegal methods to sell stock or other

investments at a price that is higher than its actual value. This

can be done through illegally manipulating the stock

price, selling stock in nonexistent companies, or using the

proceeds of later investors to pay off earlier investors (pyramid

scheme). You can avoid these kinds of fraud by following three

rules:

1. Don’t invest in small new companies that have market
   prices below $1, based on hot tips from unsolicited e-mails
   or phone calls.


2. Don’t invest on advice from acquaintances in social or re-
   ligious groups, without checking the merits yourself.


3. Don’t invest in unsolicited “risk-free” and “guaranteed” in-
   vestments that promise quick profits if you act immediately.

INTEGRITY, OBJECTIVITY, AND ETHICS IN BUSINESS