Accounting for Preferred Stock Redemption Rights

by Jack Ori

Preferred stock is a type of stock that gets priority if a company doesn't have enough funds available to pay dividends to all its stockholders. Companies can't pay dividends to common stockholders until they have paid all preferred stockholders, so in some cases preferred stockholders are the only stockholders receiving any dividend. In exchange for this privilege, preferred stockholders usually accept a flat dividend instead of a dividend based on the stock's current value.

Par Value

The par value of preferred stock tells stockholders the value of dividends they will receive for each share of preferred stock. For example, if the par value is 5 percent, stockholders will get $5 for every $100 they invested in the stock. Par value is usually listed as a percentage to make it easier to calculate how much the company must pay preferred stockholders.

Paid-In Capital

Accountants list preferred stock as a paid-in capital account. For example, if a preferred stock has a par value of $1,000, accountants list $1,000 as a paid-in capital account labeled "preferred stock." This tells the accountant how much preferred stock has been bought so that he can calculate the dividends the company must pay to preferred stockholders. If stockholders pay more than the par value to receive the preferred stock, the excess is listed as a separate paid-in capital account. For example, if an investor pays $1,200 for the stock, the excess $200 over par will be recorded as "Paid in Capital in Excess of Par - Preferred Stock."

Redemption Rights

Most preferred stock is nonparticipatory. This means that the preferred stockholders get the same dividend regardless of how much the company is worth. Preferred stockholders' dividends are based on the stock's par value, not on the company's total value. Thus accountants simply multiply the percentage of par value by the total par value to determine the dividends each preferred stockholder is entitled to. For example, if the par value is 5 percent and is $250 worth of stock, the stockholder is entitled to $12.50.

Cumulative Stock

Some preferred stock is cumulative. This means that the company didn't pay dividends to preferred stockholders in prior years and thus must pay them, along with current dividends, before paying common stockholders. If this is the case, the accountant records the entire amount of preferred dividends paid and puts a note in the business' financial statement explaining that the dividends were cumulative and the reason for the prior year's omission.

Photo Credits

  • Jupiterimages/Pixland/Getty Images