Shareholders' Equity

As noted previously, a feature of preferred shares is that they often receive preferential treatment when dividends are declared. We will now look at some examples of how dividends are calculated when preferred shares are outstanding.

Assume a company has two classes of shares: 1) common shares, of which 100,000 are outstanding with a carrying amount of $480,000, and 2) preferred shares with a fixed dividend of $2 per share, of which 20,000 are outstanding with a carrying amount of $320,000. In the current year, the company has declared total dividends of $120,000. Dividends will be allocated to each class of shares as follows:

a. Preferred shares are non-cumulative and non-participating:

Calculation	Preferred	Common	Total
Current year: 20,000 shares × $2	$ 40,000		$ 40,000
Balance of dividends ($120,000 − $40,000)	-	$ 80,000	80,000
	$ 40,000	$ 80,000	$120,000

b. Preferred shares are cumulative and non-participating, and dividends were not paid last year:

Calculation	Preferred	Common	Total
Arrears: 20,000 shares × $2	$ 40,000		$ 40,000
Current year: 20,000 shares × $2	40,000		40,000
Balance of dividends ($120,000 − $80,000)	-	-	40,000
	$ 120,000	-	$120,000

c. Preferred shares are cumulative and non-participating, and dividends were not paid for the last two years:

Calculation	Preferred	Common	Total
Arrears: 20,000 shares × $2 × 2 years	$ 80,000		$ 80,000
Current year: 20,000 shares × $2	40,000		40,000
Balance of dividends ($120,000 − $120,000)	-	-	-
	$ 80,000	-	$120,000

d. Preferred shares are non-cumulative and fully participating:

Calculation	Preferred	Common	Total
Current year basic dividend	$ 40,000	$ 60,000	$100,000
Current year participating dividend	$ 8,000	$ 12,000	20,000
	$ 48,000	$ 72,000	$120,000

Note: The basic preferred dividend is calculated as before. Then, a like amount is allocated to the common shares. The preferred dividend can be expressed as a percentage: $40,000 ÷ $320,000 = 12.5%. Therefore, the common shares are also allocated a basic dividend of (12.5% ×$480,000) = $60,000. This leaves a remaining dividend of $20,000, which is available for participation. The participation is allocated on a pro-rata basis as follows:

Carrying amounts of each class:

Preferred	$320,000	40%
Common	480,000	60%
Total	$800,000	100%

 The participating dividend is therefore:

Preferred	$20,000 × 40% = $ 8,000
Common	$20,000 × 60% = $12,000

If the preferred shares were cumulative and fully participating, the process followed is the same as above, except the dividends available for participation must be reduced by any preferred dividends in arrears, as these must be paid first before any dividends can be paid to common shareholders.

The pro-rata allocation of the participating dividend, shown above, is one way to determine the rate of participation. However, if a company's articles of incorporation specify other methods of participation for different classes of shares, then these calculations must be applied instead.