Corporations issue preferred stock to investors in exchange for financial resources to use in the business. Preferred stock represents a class of capital stock that receives preferential treatment in regard to dividends. Corporations pay dividends on preferred stock before paying any dividends to common stockholders. Preferred stock may also carry other benefits for the stockholders, such as being cumulative. Cumulative preferred stockholders receive dividends for all prior years which dividends have not been paid before any dividends can be paid to common stockholders.
Preferred Stock Dividend Payments
Each share of preferred stock includes a stated dividend rate, which determines the amount of the dividend to be paid to the preferred stockholders. The stated dividend rate may be written as a dollar amount per share. In this situation, the preferred stockholder receives that amount for each share of stock owned. The stated dividend rate may also be written as a percentage of the stock’s par value. The par value represents an arbitrary dollar amount assigned to each share of stock. In this situation, the preferred stockholder receives an amount equal to the par value times the stated percentage rate.
Preferred Stock Dividend Classification
Preferred stockholders represent owners of a corporation. They exist in a separate class from common stockholders, but are still owners. When the corporation issues preferred stock, it records the money received as stockholder’s equity. Dividend payments represent a return on that equity and reduce the total stockholder’s equity of the corporation.
Components of Net Income
The two main components of net income include revenues and expenses. A company identifies each of the revenues earned and each of the expenses incurred by the corporation, and reports these components on its income statement. Preferred stock dividends are not revenues to the corporation since it is not earning anything. Additionally, preferred stock dividends are not expenses because the corporation did not incur these charges in order to earn income.
Calculation of Net Income
Corporations calculate and report net income on an income statement. The basic format of an income statement consists of listing the revenues, subtracting the expenses and determining net income. Preferred stock dividends do not qualify as revenues or expenses, so they are not reported on the income statement. As a result, preferred stock dividends do not impact net income.