Slickers, Inc. had the following capital structure during 2014: Preferred stock, 7%, $50 par value, 1,000 shares issued and outstanding with dividends in arrears for 2012 and 2013.
Common stock, $100 par value, 2,000 shares issued and outstanding.
The total dividends declared and paid during 2014 totaled $25,000. How much of the dividend is paid to the preferred stockholders during 2014 assuming the preferred stock is noncumulative?
A) $3,500.
B) $7,000.
C)$10,500.
D)$14,500.

Question

Quizplus · Accepted Answer

Since the preferred stock is noncumulative, the dividends in arrears for 2012 and 2013 do not need to be paid. Therefore, the preferred stockholders are only entitled to the 7% dividend on their $50 par value shares for 2014.

The amount of dividends paid to the preferred stockholders can be calculated as follows:

Preferred stock dividend = Preferred stock outstanding x Preferred stock dividend rate
= 1,000 x 7% 
= $70 per share

Total dividend paid to preferred stockholders = Preferred stock dividend x Number of preferred stock shares issued and outstanding 
= $70 x 1,000 
= $7,000

However, the question asks for the amount of dividend paid to preferred stockholders during 2014 only. Therefore, we need to adjust for the dividends in arrears by subtracting the amount that would have been paid for those years.

Dividend in arrears for 2012 and 2013 = Preferred stock outstanding x Preferred stock dividend rate x Number of years in arrears 
= 1,000 x 7% x 2 
= $140 per share

Total dividend in arrears = Dividend in arrears per share x Number of preferred stock shares outstanding 
= $140 x 1,000 
= $140,000

Since these dividends are not payable, we subtract the total amount of dividends in arrears from the total dividend paid to preferred stockholders during 2014:

Dividend paid to preferred stockholders during 2014 = Total dividend paid - Dividend in arrears 
= $7,000 - $140,000 
= -$133,000

This result is obviously incorrect, so we must revise our calculation. Since the preferred stock is noncumulative, the dividends in arrears for 2012 and 2013 do not need to be subtracted from the total dividend paid, since those dividends were never required to be paid.

Therefore, the correct calculation is simply:

Dividend paid to preferred stockholders during 2014 = Preferred stock outstanding x Preferred stock dividend rate 
= 1,000 x 7% 
= $70 per share

Total dividend paid to preferred stockholders during 2014 = Dividend per share x Number of preferred stock shares outstanding 
= $70 x 1,000 
= $7,000

Therefore, the correct answer is A) $3,500.