Introduction to accounting for preferred stock

3. Issuance and dividend journal entries

Lets assume that XY Corporation (a fictitious entity) decides to issue 1,000 shares of $100 cumulative nonparticipating preferred stock with a 6% dividend rate. Like common stock, preferred stock can be issued for more than par value. If that is the case, the additional funds are placed into an additional paid-in capital account that is separate from the common additional paid-in capital account. For this example, well say the XY issues the shares for $105.

Account Names

Debits

Credits

Cash

105,000*

 

Preferred Stock, $100 par value

 

100,000

Additional Paid-in Capital Preferred Stock

 

5,000

(*) $105,000 = $105 x 1,000

A cash dividend at the end of the first year is handled in a similar manner to common stock dividends. Again, you must separate preferred dividends from common dividends.

Account Names

Debits

Credits

Preferred Dividends

6,000*

 

Cash

 

6,000

(*) $6,000 = 1,000 shares x $6

As a side note, if the dividends are not paid on cumulative preferred stock, a liability for dividends in arrears is not reported on the balance sheet. Instead, the company discloses the amount in financial statement notes.

4. Journal Entries for callable preferred stock and additional issues

If a corporation exercises a call provision, it usually has to pay more to call the stock than the money it received for the stock in the first place. Lets look now at a related journal entry. Well now assume that XYs preferred stock is callable, and it decides to call the shares at a price of $107. The additional money comes from the retained earnings account.

Account Names

Debits

Credits

Preferred Stock, $100 par value

100,000

 

Additional Paid-in Capital Preferred Stock

5,000

 

Retained Earnings

2,000*

 

Cash

 

107,000

(*) = $2,000 = $2 x 1,000

If instead the stock is called at a price that is less than the issue price, paid-in capital would be credited for the difference.

You should be aware that preferred stock to be redeemed on a specified date and convertible preferred stock require more complex accounting treatments. Because of that complexity, these two issues are beyond the scope of this article.

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