Preferred stock has rights beyond those of common stock (often compared to the rights of creditors). In the event of a liquidation, owners of preferred stock are paid after creditors, but before owners of common stock. They also have the right to be paid dividends before any dividends can be paid to common stock owners.
Preferred stock is usually authorized at a set price, which is the par value. If the stock sells for more than par, then it is sold at a premium. While common stock provides no statements concerning payment of dividends, preferred stock provides for a dividend payment that is stated as a percentage of par value.
For example, if par for our preferred stock is $100 and the dividend right is 5%, then the holders of preferred shares have the right to receive a $5 ($100 x 5%) dividend per share each year that dividends are declared and paid. The right of preferred shareholders takes priority over common stock shareholders. However, there is no guarantee that dividends will be declared; therefore, preferred shareholders may receive nothing.
Since the company must pay the preferred shareholders before the common stockholders, the company must declare enough dividends to cover both the required payment and the amount that it wants to pay the common shareholders.
A corporation is authorized to issue 3,000 shares of $25 par, 4% preferred stock. On March 2, 2017, the company issues 1,000 shares at a price of $30 per share. The entry to record this transaction is shown below:
| Date | Accounts and explanation | Debit | Credit |
|---|---|---|---|
| March 2, 2017 | Cash | $30,000 |
-
|
|
-
|
Preferred stock
|
-
| $25,000 |
|
-
|
Paid-in capital in excess of par value
|
-
| $5,000 |
|
-
| Issued preferred stock at a premium. |
-
|
-
|
Calculations:
If we assume that this is the only preferred stock transaction and the company has issued 1,000 out of its authorized 10,000 shares of $2 par common stock for $5 per share, the stockholders’ equity section of the balance sheet would appear as follows (assuming a balance in retained earnings of $10,000):
| Paid-in capital: |
-
|
|
Preferred stock ($25 par value, 4% preferred; 3,000 shares
authorized; 1,000 shares issued and outstanding) | $25,000 |
|
Paid-in capital in excess of par value (preferred)
| $5,000 |
|
Common stock ($2 par value; 10,000 shares authorized;
1,000 shares issued and outstanding) | $2,000 |
|
Paid-in capital excess of par value (common)
| $3,000 |
| Total paid-in capital | $35,000 |
| Retained earnings | $10,000 |
| Total stockholders' equity | $45,000 |