Question

Carington Corp. has outstanding 10 million shares of $2 par value common stock and 1 million shares of 7% $4 par value preferred stock. The company declares total dividends amounting to $50,000, $250,000, and $600,000 during 2017,2018, and 2019, respectively. Calculate the amount of dividends to be distributed to preferred and common shareholders under each of the two following scenarios:

A) The preferred stock is noncumulative

B) The preferred sock is cumulative

Answer 1

Carington Corp

1. Allocation of dividends between preferred stock and common shares assuming preferred stock to 7%, non-cumulative:

	2017	2018	2019
Allocation to Preferred Stock	$50,000	$250,000	$280,000
Allocation to Common Stock	0	0	$320,000

Preferred dividend = $4 x1,000,000 x 7% = $280,000

However, in year 2017, the cash dividends were only 50,000. Hence, the entire dividends are allocated to preference stock holders as this class of shareholders have preference over equity class for distribution of dividends.

In Year 2018, again the cash dividends were only 250,000. Hence, the entire dividends are allocated to preference stock holders as this class of shareholders have preference over equity class for distribution of dividends.

Similarly, in Year 2019, $280,000 dividends are first allocated to preference holders and the remaining $320,000 is allotted to equity shareholders.

1. Allocation of dividends to each class of stock, assuming the preferred stock dividend is 7% and cumulative:

	2017	2018	2019
Allocation to Preferred Stock	$50,000	$250,000	$540,000
Allocation to Common Stock	0	0	$60,000

Preferred stock dividend = $4 x 1,000,000 x 7% = $280,000

2017 allocation = dividend available = $50,000

Hence the entire dividend is allocated to preference stock holders.

Since, the class is cumulative the difference between actual dividends and allocated dividends is carried forward and allocated in the subsequent years.

Therefore, in Year 2018, allocation to preferred dividend = $280,000 + (280,000 – 50,000) = $510,000

However, dividends paid = $250,000

So, preference shareholders are paid $250,000, no dividends to equity and the cumulative portion of preferred dividend carried forward to 2019 is $510,000 – 250,000 = $260,000

For the year 2019, preferred dividend payable is 280,000 + 260,000 = $540,000. The remaining amount in dividends is fully allotted to equity holders, 600,000 – 540,000 = $60,000