MODULE 5 PART 5

DIVIDENDS ON PREFERENCE &

ORDINARY SHARES
PREFERENCE SHARES
❑PREFERENCE SHARE is one class of share in a company that once issued, the shareholders
have the right to receive part of the company’s profits before the holders of ordinary shares
are paid.
❑CERTAIN FEATURES:
➢ It is a par value share.
➢ Voting rights in special circumstances only.
➢ Generally considered a hybrid instrument , it has properties of both equity and debt
instrument.
➢ It carries a definite rate of dividend , though generally lower than that declared on ordinary
shares, which may be cumulative or non-cumulative.
➢ The holder has the right to have their capital repaid if the company fails and has to close the
business.
DIVIDEND ON PREFERENCE SHARES
❑Preference share dividend - is a dividend that is accrued and paid on a company’s preference
shares.
➢ When the BOD declares cash dividends, the preference shareholders enjoy preference or are
priority before ordinary shareholders received any distribution.
➢ If the company is unable to pay all dividends, claims to preference share dividends take
precedence over claims to dividends that are paid to ordinary shares.

The corporation is not obliged to declare dividends annually .

FOUR CATEGORIES :
1. CUMULATIVE and PARTICIPATING
2. CUMULATIVE and Non-PARTICIPATING
3. Non-CUMULATIVE and PARTICIPATING
4. Non-CUMULATIVE and Non-PARTICIPATING
DIVIDEND...
❑ CUMULATIVE Preference Shares-it include a provision that requires the company to pay the shareholders
not only all current dividends but also dividend in arrears (back dividends) when declared. The accumulated
unpaid dividends over the years will be disclosed in the accompanying notes to financial statement.
❑ NON-CUMULATIVE Pref. Shares - the holders are entitled to be paid all current dividends only, before
ordinary shareholders when dividends are declared. If there is no dividend declaration for a certain year
then the dividend for that year is forfeited.
❑ PARTICIPATING Pref. Shares – holders are entitled to participate with the holders of ordinary shares pro-
rata in the remainder after the ordinary shareholders have received their initial shares based on preference
rate
❑ NON-PARTICIPATING Pref. Shares – holders are entitled only to the extent of the stipulated preference
dividend.

In the absence of agreement, preference shares are assumed to be NON-CUMULATIVE AND NON-
PARTICIPATING in accordance with the provision that each share shall be equal in all respects to other share
except as otherwise provided by the articles of incorporation and stated in the certificate of stock. (Section 6
paragraph 5, Corp. Code of the Phils.
CONTINUED...
DIVIDEND in arrears-a dividend payment associated with cumulative preference shares that has
not been paid to shareholders on the expected date. It do not constitute a legal liability until
there is declaration by the BOD.
➢ If the financial circumstances of the company does not allow, the board will not declare
dividends. but to cumulative holders, the dividends will accumulate and when the time comes
that the board declares dividend they will be paid first before the ordinary shareholders.

EXAMPLE: IF a corporation has cumulative preference share with annual dividend of P10,000 and
it has three (3) years dividend in arrears amounting to P30,000, then the corporation shall have
to pay first its preference shareholders P40,000 (30,000 + 10,000)before the ordinary shares gets
their share of dividends. But assuming the corporation pays only a total of P5,000 dividends in
the current year, the preference shareholders will receive the entire P5,000, so that the balance
of dividend in arrears will be P35,000 at the end of the current year. No dividend to ordinary
shares for the current year.
ILLUSTRATION
PROBLEM: BSA Inc., a distributor of medical supplies and equipment has the following data in
each Shareholders’ Equity accounts as of December 31, 2018 as follows:
8% Preference Shares , P100 par, 5000 shares authorized,
3,000 shares issued and outstanding...................................................P 300,000
Ordinary Shares, P100 par, 10,000 shares authorized,
5,000 shares issued and outstanding................................................... 500,000
Retained Earnings ................................................................................... 220,000

NOTE: Due to insufficient cash, the board did not declare dividends for the periods: 2015,
2016, and 2017. This year 2018, the company’s board decided to pay cash dividends
equivalent to 70% of its Retained Earnings balance. Calculate the amount of dividend
that each class of stock will receive under the following cases:
Dividend Declared = P220,000 (RE) x 70% = P154,000
CASE 1. CUMULATIVE and PARTICIPATING PREFERENCE SHARE
Share holders are entitled to omitted dividends or in arrears and right to participate peso to
peso with ordinary shareholders in the remaining dividends as additional dividend share.
PREFERENCE ORDINARY TOTAL
Outstanding Share Capital P 300,000 P 500,000 P 800,000
Preference dividends in arrears
P300,000 x 8% x 3 years P 72,000 P 72,000
Preference dividend current yr.
P300,000 x 8% 24,000 24,000
Current Ordinary Share
dividend = P500,000 x 8% at PS 40,000 40,000
rate
Remainder for participation:
(154,000-72,000-24,000-40,000
=P18,000)
Preference = 3/8 x 18,000 6,750 6,750
Ordinary = 5/8 x 18,000 11,250 11,250
TOTAL P 102,750 P 51,250 P 154,000
DIVIDEND PER SHARE P 34.25 P 10.25
CASE 2. CUMULATIVE and NON- PARTICIPATING PREFERENCE SHARE
The shareholders are entitled to dividend in arrears but cannot participate in the remaining
dividends. Ordinary shareholders get all the remainder after preference has been fully satisfied.

PREFERENCE ORDINARY TOTAL

Outstanding Share Capital P 300,000 P 500,000 P 800,000
Preference dividends in arrears
P300,000 x 8% x 3 years P 72,000 P 72,000

Current Preference dividend

P300,000 x 8% 24,000 24,000

Remainder to Ordinary Shares

P154,000-72,000-24,000 P 58,000 58,000

TOTAL P 96,000 P 58,000 P 154,000

DIVIDEND PER SHARE P 32.00 P 11.60
CASE 3: NON-CUMULATIVE AND PARTICIPATING PREFERENCE SHARE
Shareholders are only entitled to current period dividend . After ordinary shareholders had been
given their basic share at a declared rate, both preference and ordinary holders will share the
remaining dividends.
PREFERENCE ORDINARY TOTAL
Outstanding Share Capital P 300,000 P 500,000 P 800,000
Preference Share dividend
Current P300,000 x 8% 24,000 24,000
Ordinary Share dividend
Current @ preference rate
P500,000 x 8% 40,000 40,000
Remainder for Participation
P154,000-24,000-40,000
=P90,000
Preference =3/8 x 90,000 33,750 33,750
Ordinary =5/8 x 90,000 56,250 56,250
TOTAL P 57,750 P 96,250 P 154,000

DIVIDEND PER SHARE P 19.25 P 19.25

CASE 4: NON-CUMULATIVE AND NON-PARTICIPATING PREFERENCE SHARE
In this category of dividends, the preferred shareholders will not be paid of the omitted dividend
in the subsequent year and they are not entitled to participate in the balance of dividend after
their stipulated share is given. All remainder goes to ordinary shareholders regardless of the size
of the dividend.
PREFERENCE ORDINARY TOTAL
Outstanding Share Capital P 300,000 P 500,000 P 800,000

Preference Share dividend

Current P300,000 x 8% 24,000 24,000

Remainder to Ordinary
P154,000-24,000=130,000 130,000 130,000

TOTAL P 24,000 P 130,000 P 154,000

DIVIDEND PER SHARE P 8.00 P 26.00

LIQUIDATING DIVIDENDS
❑LIQUIDATING DIVIDENDS are distributions to shareholders that comes from
its capital base or the amount that shareholders invested in the company. It is not
a regular dividend income for the shareholders, but it represents a return of the
shareholder’s original investment, therefore, they are not usually taxed.

➢This dividend is paid out after all creditor and lender obligations have been
settled.
➢The liquidating dividend payout is the last action taken before the business is
closed . Its legality depends on the followings circumstances:
1) The corporation is under the process of dissolution and liquidation
2) The corporation is engaged in the exploration of natural resources.
RESTRICTIONS ON RETAINED EARNINGS
When there is a need to appropriate or reserve the free retained earnings, there will not be
available for distribution, and the BOD has to pass a resolution to that effect and such resolution
should be recorded in the books as follows:
EX: Acme Trading, a customer, filed a lawsuit against BSA Inc. , for defective products and breach
of contract. To be able to deal with the situation without bias, the management decided to avail
of the services of outside party who are experts and together with the company lawyers
estimated the damage to be P150,000. Based on the assessment, the BOD establish a restriction
on RE to free it for possible lawsuit. The entry would be:
Retained Earnings.................................................................P150,000
Appropriated Retained Earnings-Law suit.......................................P150,000
To restrict RE for the cost of lawsuit.
Upon settlement of the damages, BOD will order for that restrictions on lawsuit to be lifted and
reversing entry would be established :
Appropriated RE – Law suit ................................................ P150,000
Retained earnings ..............................................................................P150,000
THE STATEMENT OF RETAINED EARNINGS
As per revised International Accounting Standards (IAS) No. 1, Statement of
Retained Earnings is not included among the required financial statements. For
presentation purposes , retained earnings statement is normally divided into two
major sections
A. APPROPRIATED-this section presents the beginning balance of RE
appropriated account , any additions or deductions during the
period, and the ending balance.
B. UNAPPROPRIATED-This section shows the beginning balance of RE
unappropriated account, correction of prior periods, profit or loss
for the period, dividends, transfers to and from appropriated
and unappropriated accounts and the ending balance.
 BOOK VALUE PER SHARE
❑ BOOK VALUE PER SHARE (BVPS)- represents the value of equity or the amount to be paid to shareholders of
records assuming that the Company after paying up all debts and the company’s assets are to be liquidated.
➢ It is used as indicator of the value of company’s stock and it can be used to predict the possible market price of a
share at a given time in the future.

WHAT TO KNOW ABOUT BVPS?

➢ The amount available to shareholders is exactly the amount reported as Ordinary Shareholders’ Equity.
➢ Preferred Shares are excluded from the value of equity because preferred shareholders are ranked higher than the
ordinary shares during liquidation.
➢ When only a single class of stock is outstanding, the BVPS is computed by dividing the total shareholders’ equity by
the number of ordinary shares outstanding as:
BOOK VALUE PER SHARE = Shareholders’ Equity / Number of Ordinary Outstanding Shares

Or BVPS = Stockholders’ Equity – Preferred Shares Equity/Average shares Outstanding

*Average shares outstanding is used because the closing period may skew results if there was a stock issuance or major stock
buyouts.
BOOK VALUE...
When there are two kinds of stock,
➢ FIRST, compute the Book Value Per Share of preference shares as:
BVPS of Preference Shares = Preference Shareholders’ Equity / No. of Preference shares
Outstanding
PREF. SHAREHOLDERS’ EQUITY = Total amount of preference share at par value plus any
current and dividend in arrears.

➢ Second, compute the book value per share of ordinary shares:

BVPS of Ordinary Shares = Ordinary Shareholders’ Equity / No. of ordinary Shares
Outstanding
ORDINARY SHAREHOLDERS’ EQUITY is the residual amount after deducting the preference
shareholders’ equity from the Total Shareholders’ Equity.
ILLUSTRATION
CASE 1 Single Stock
Assuming BSA Inc.’s Shareholders’ Equity section as of December 31, 2018 revealed the following
balances:

Ordinary shares, issued and outstanding, 3,000 @P100 par P 300,000

Share premium-ordinary 30,000
Retained earnings 78,000
Increment in property revaluation 45,000
Treasury Stock ( 3,000)
TOTAL SHAREHOLDERS’ EQUITY P 450,000

Book Value Per Share = P 450,000 / 3,000 = P 150 per share

For purposes of value computation, treasury shares should be treated as

retired shares of stock and therefore deducted from total share capital.
ILLUSTRATION
CASE 2 Two classes of Stock (Ordinary and Non-cumulative preference share)
Assuming BSA Inc.’s Shareholders’ Equity section as of December 31, 2018 revealed the following
balances:
12% Preference shares
Issued and outstanding , 1,000 @ P100 par , non-cumulative P 100,000
Ordinary shares, issued and outstanding, 3,000 @P100 par 300,000
Share premium-ordinary 30,000
Retained earnings 78,000
Increment in property revaluation 45,000
Treasury Stock ( 3,000)
TOTAL SHAREHOLDERS’ EQUITY P 550,000

The last dividend payment to preference share was in 2015.

Rule, in the absence to the contrary, preference shares, is

assumed to be non-cumulative and non-participating.

SOLUTION NEXT SLIDE

SOLUTION
1. Compute the preference Shareholders’ Equity , first
Preference share at par................................................................P 100,000
Current dividend @ 12% (2018)................................................. 12,000
Total .................................................................................................P 112,000
Book Value per share of Preference Share = P112,000 / 1,000 shares = P112 per share

2. Compute the Ordinary Shareholders’ Equity

Total Stockholders’ Equity.............................................................P550,000
Less: Preference Shareholders’ Equity......................................... 112,000
Ordinary Shareholders’ Equity .................................................... 438,000
Book Value per share of Ordinary Share = 438,000 / 3,000 shares = P146 per share.

NOTE: There will be changes in the BVPS if preference holders is cumulative.

 BOOK VALUE VS. MARKET VALUE
BOOK VALUE MARKET VALUE
▪ Total value of business’ assets found on its ▪ The worth of a company based on the total
balance sheet and represents the value of value of its outstanding shares in the market
all its assets if liquidated. or its market capitalization.
▪ Calculates the ordinary share book value ▪ It is the company’s current share price in the
of a company. stock market.
▪ It is based on historical costs and a ▪ It is forward looking metric that takes into
conservative way for investors to measure account a company’s earning ability or future
the real value of a company’s stocks. periods earning power.
▪ Value investors prefer BVPS as a gauge of ▪ It provides a concrete method that eliminates
stock’s potential value when future uncertainty for determining what an asset is
growth earnings projections are less worth.
stable.