---
title: "Preferred Dividends | Financial Accounting I"
description: "Preferred dividends are the fixed payments owed to preferred shareholders before common dividends, and they affect EPS and equity reporting in Financial Accounting I."
canonical: "https://fiveable.me/financial-accounting/key-terms/preferred-dividends"
type: "key-term"
subject: "Financial Accounting I"
---

# Preferred Dividends | Financial Accounting I

## Definition

Preferred dividends are the fixed dividends paid to preferred shareholders before any dividends go to common shareholders. In Financial Accounting I, they also reduce earnings available to common stock when you calculate EPS.

## What It Is

Preferred dividends are the dividends paid to preferred stockholders before common stockholders receive anything. In Financial Accounting I, that priority matters because preferred stock sits between liabilities and common equity in the equity section, and its dividends are treated differently from common dividends.

Most preferred stock pays a stated dividend rate, so the dividend amount is usually predictable. For example, if a company issues preferred shares with a 6% dividend rate on a stated value, the annual dividend is based on that fixed rate, not on how much profit the company happened to make that year. That makes preferred dividends more like a promised return than a variable reward.

The big idea is priority. If a board declares a dividend, preferred shareholders are first in line. Common shareholders only receive dividends after preferred dividends are covered. If there is not enough cash or the company skips a payment, the accounting treatment depends on whether the preferred stock is cumulative or non-cumulative.

Cumulative preferred dividends build up when unpaid. That means skipped dividends do not disappear, and the company has to catch up before common dividends can be paid. Non-cumulative preferred dividends do not pile up, so if the company misses a period, those unpaid dividends are gone unless the board later declares a new dividend.

This term also shows up when you calculate earnings per share. EPS is meant to show how much of net income belongs to common shareholders, so preferred dividends are subtracted from net income before the EPS formula is applied. That is why preferred dividends are not just a cash distribution detail, they change the amount of earnings available to common stock.

A simple way to think about it is this: preferred dividends are a senior claim on profits, while common dividends are residual. The preferred shareholder gets the fixed piece first, and whatever is left can be shared with common shareholders if the company chooses to distribute it.

## Why It Matters

Preferred dividends matter because they change how you read both the equity section and the income available to common shareholders. If you see preferred stock on a balance sheet or in a note to the financial statements, you need to know that its dividends come before common dividends and can affect how much return flows to common owners.

This concept also connects directly to EPS, which is one of the main performance measures in Financial Accounting I. A company can report solid net income but still have less income available to common shareholders after preferred dividends are removed. If you skip that step, your EPS calculation will be wrong.

Preferred dividends also help you interpret dividend policy. A company with preferred stock is making a commitment to pay a fixed dividend first, which affects how much flexibility management has when deciding whether to pay common dividends. That matters in case questions about profitability, financing choices, or why a company may retain earnings instead of distributing them.

You will also run into this term when comparing different classes of stock. Preferred stockholders usually do not vote the same way common stockholders do, but they get dividend priority. That tradeoff shows up a lot in accounting questions about equity financing and earnings distribution.

## Connections

### Earnings Per Share (EPS)

Preferred dividends are subtracted before you calculate basic EPS because EPS is meant to measure earnings available to common shareholders. If you forget that deduction, you overstate the amount of profit tied to each common share. This is one of the most common places the term shows up in Financial Accounting I problems.

### [Common Stock](/financial-accounting/key-terms/common-stock)

Common stockholders are last in line for dividends after preferred shareholders are paid. That makes preferred dividends a direct limit on what common shareholders can receive. When you compare the two classes, the key difference is priority versus residual claim.

### Dividend Policy

Dividend policy gets more complicated when a company has preferred stock outstanding. Management has to account for the fixed preferred dividend before deciding whether common dividends are possible. That is why preferred dividends can shape cash distribution decisions even when net income looks strong.

### [weighted average common shares outstanding](/financial-accounting/key-terms/weighted-average-common-shares-outstanding)

This term appears in the denominator of basic EPS, while preferred dividends are part of the numerator adjustment. Together, they show why EPS is not just net income divided by shares. You need both pieces to get the amount available to each common share.

## On the AP Exam

A quiz or problem set question usually asks you to compute EPS, identify who gets paid first, or decide whether unpaid dividends carry forward. You might be given net income, preferred dividends, and weighted average common shares outstanding, then asked to calculate earnings available to common stock. In a multiple-choice question, watch for the trap of using total net income without subtracting preferred dividends.

You may also see a short scenario about skipped dividends. The task is to tell whether the preferred stock is cumulative or non-cumulative and whether common dividends can be paid yet. If a problem mentions arrears or unpaid preferred dividends, that is your clue that those dividends may still need to be covered before common shareholders receive anything.

## Preferred Dividends vs Common Stock

Preferred dividends are not the same thing as common stock dividends. Preferred dividends go to preferred shareholders first and are usually fixed, while common stock dividends are paid only after preferred claims are satisfied and often vary with company performance. The confusion usually happens because both are distributions of earnings, but the priority and calculation treatment are different.

## Key Takeaways

- Preferred dividends are paid to preferred shareholders before any dividends go to common shareholders.
- The dividend is usually fixed or stated at a set rate, so it is more predictable than common dividends.
- Cumulative preferred dividends build up if they are unpaid, while non-cumulative dividends do not.
- Preferred dividends are subtracted from net income when calculating earnings available to common shareholders and basic EPS.
- If you see a dividend question in Financial Accounting I, ask first whether preferred stock exists and whether those dividends have been paid or skipped.

## FAQs

### What is Preferred Dividends in Financial Accounting I?

Preferred dividends are the payments made to preferred shareholders before any money is distributed to common shareholders. In Financial Accounting I, they matter because they affect both dividend priority and the EPS calculation. They are usually based on a fixed rate, not on whatever profit the company happens to earn.

### Are preferred dividends always paid every year?

No. If the company has enough cash and the board declares a dividend, preferred shareholders are paid according to their terms. If the company skips a payment, cumulative preferred dividends may build up, but non-cumulative preferred dividends do not carry forward.

### How do preferred dividends affect EPS?

Preferred dividends reduce the earnings available to common shareholders, so they are subtracted from net income before calculating basic EPS. That means EPS is not based on total net income alone. It is based on what belongs to common shareholders after preferred claims.

### What is the difference between cumulative and non-cumulative preferred dividends?

Cumulative preferred dividends pile up if they are not paid, so unpaid amounts stay owed before common dividends can be distributed. Non-cumulative preferred dividends do not accumulate, so missed payments do not create a back balance. This difference is a common exam and homework question.

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