How do cumulative preferred dividends in arrears affect the financial statements and basic EPS?

Cumulative preferred stock guarantees that if the company skips a dividend payment, the unpaid amount accumulates and must be paid before any common dividends can be distributed. However, the accounting treatment of these "arrears" has some nuances that are heavily tested.

Are Dividends in Arrears a Liability?

No. Dividends in arrears are NOT a liability until formally declared by the board of directors. They are disclosed in the notes to the financial statements but do not appear on the balance sheet as a payable.

Why not a liability? A company has no legal obligation to ever pay dividends. The cumulative feature only means that IF dividends are eventually declared, preferred holders must receive all accumulated unpaid amounts first.

Impact on Basic EPS:

Here is the critical rule:

• Cumulative preferred: Subtract the FULL annual preferred dividend from net income for basic EPS, regardless of whether declared
• Non-cumulative preferred: Subtract preferred dividends from net income only if declared

This is because with cumulative preferred, the preferred dividend is effectively a claim on earnings each period, whether paid or not.

Worked Example — Westford Dynamics:

Westford has 50,000 shares of 5%, $40 par cumulative preferred stock. The board did NOT declare dividends in 2024 or 2025. In 2026, the board declares total dividends of $500,000.

Dividends in arrears:

Annual preferred dividend = 50,000 × $40 × 5% = $100,000/year

Arrears (2024 + 2025) = 2 × $100,000 = $200,000

Current year (2026) preferred = $100,000

Total to preferred = $300,000

Available to common = $500,000 − $300,000 = $200,000

EPS Impact Each Year:

Net income: 2024 = $800,000; 2025 = $900,000; 2026 = $1,200,000

Common shares outstanding: 400,000

Notice: For EPS purposes, you subtract $100,000 EACH year — NOT the full $300,000 in 2026. The arrears from 2024 and 2025 were already subtracted in those years' EPS calculations.

Disclosure Requirements:

The notes must disclose:

• The amount of dividends in arrears per share and in total
• The number of cumulative preferred shares outstanding
• The aggregate amount of the arrears

Key Exam Trap: A common mistake is subtracting all accumulated arrears in the year they are finally paid. For EPS, the current-year preferred dividend is always just the annual amount.

For more EPS and equity practice, explore our CFA Level I materials.