Chapter 11, Problem 11.8P

Comparing Stock and Cash Dividends

Chicago Company reported the following information at the end of the current year:

Common stock ($8 par value; 35,000 shares outstanding)	$280,000
Preferred stock, 10% ($15 par value; 8,000 shares outstanding)	12,000
Retained earnings	281,000

The board of directors is considering the distribution of a cash dividend to the two groups of stockholders. No dividends were declared during the previous two years. Assume the three cases below are independent of each other.

Case A: The preferred stock is noncumulative: the total amount of all dividends is $31,000.

Case B: The preferred stock is cumulative; the total amount of all dividends is $36,000.

Case C: The preferred stock is cumulative: the total amount of all dividends is $90,000.

Required:

1. 1. Compute the amount of dividends, in total and per share, that would be payable to each class of stockholders for each case. Show computations.
2. 2. Assume Chicago Company issued a 30 percent common stock dividend on the outstanding shares when the market value per share was $24. Fill in the table below to show how this stock dividend would compare to Case C.

AMOUNT OF DOLLAR INCREASE (DECREASE)
Item	Cash Dividend—Case C	Stock Dividend
Assets	$	$
Liabilities	$	$
Stockholders’ equity	$	$

To determine

Compute the amount of dividends, in total and per share, that would be payable to each class of stockholder’s for each case.

Explanation of Solution

Preferred stock:

The stock that provides a fixed amount of return (dividend) to its stockholder before paying dividends to common stockholders is referred as preferred stock.

Common stock:

These are the ordinary shares that a corporation issues to the investors in order to raise funds. In return, the investors receive a share of profit from the profits earned by the corporation in the form of dividend.

Retained earnings:

Retained earnings are the portion of earnings kept by the business for the purpose of reinvestments, payment of debts, or for future growth.

Cash dividends:

The amount of cash provided by a corporation out of its distributable profits to its shareholders as a return for the amount invested by them is referred as cash dividends.

Compute the amount of dividends, in total and per share, that would be payable to each class of stockholder’s for each case:

Case A: Preferred is noncumulative and the total amount of all dividends is $31,000.

Particulars	Preferred Stock of 8,000 shares (Amount in $)	Common Stock of 35,000 shares (Amount in $)	Total (Amount in $)
Preferred shares $\left(\$120,000\times 10\%\right)$	12,000		12,000
Balance carried to common stock		(1)19,000	19,000
	12,000	19,000	31,000
Per share value	(2) 1.50	(3) 0.54

(Table 1)

Working Notes:

$\begin{array}{c}\text{Balance carried to common stock = }\left(\text{Total amount of all dividends }-\text{Preferred shares}\right)\\ =\$31,000-\$12,000\\ =\$19,000\end{array}$ (1)

$\begin{array}{c}\begin{array}{l}\text{Per share value of perferred}\\ \text{ stock of 8,000 shares}\end{array}\}\text{ = }\frac{\text{Dividend}}{\text{Perferredstock}}\\ =\frac{\$12,000}{8,000\text{ Shares}}\\ =1.50\end{array}$ (2)

$\begin{array}{c}\begin{array}{l}\text{Per share value of common}\\ \text{ stock of 35,000 shares}\end{array}\}\text{ = }\frac{\text{Dividend}}{\text{Common stock}}\\ =\frac{\$19,000}{35,000\text{ Shares}}\\ =0.54\end{array}$ (3)

Case B: Preferred is cumulative and the total amount of all dividends is $36,000.

Particulars	Preferred Stock of 8,000 shares (Amount in $)	Common Stock of 35,000 shares (Amount in $)	Total (Amount in $)
Preferred shares:
Arrears $\left(\text{\$120,000×10\%×2years}\right)$	24,000	0	24,000
Current year $\left(\text{\$120,000×10\%}\right)$	12,000	0	12,000
	36,000	0	36,000
Per share value	(4) 4.50	0

(Table 2)

Working Notes:

$\begin{array}{c}\begin{array}{l}\text{Per share value of perferred}\\ \text{ stock of 8,000 shares}\end{array}\}\text{ = }\frac{\text{Dividend}}{\text{Perferredstock}}\\ =\frac{\$36,000}{8,000\text{ Shares}}\\ =4.50\end{array}$ (4)

Case C: Preferred is cumulative and the total amount of all dividends is $90,000.

Particulars	Preferred Stock of 8,000 shares (Amount in $)	Common Stock of 35,000 shares (Amount in $)	Total (Amount in $)
Preferred shares:
Arrears $\left(\text{\$120,000×10\%×2years}\right)$	24,000	0	24,000
Current year $\left(\text{\$120,000×10\%}\right)$	12,000	0	12,000
Balance of common stock	0	54,000	54,000
	36,000	(5) 54,000	90,000
Per share value	(4) 4.50	(6)1.54

(Table 3)

Working Notes:

$\begin{array}{c}\text{Balance carried to common stock = }\left(\text{Total amount of all dividends }-\text{Preferred shares}\right)\\ =\$90,000-\$36,000\\ =\$54,000\end{array}$ (5)

$\begin{array}{c}\begin{array}{l}\text{Per share value of common}\\ \text{ stock of 35,000 shares}\end{array}\}\text{ = }\frac{\text{Dividend}}{\text{Common stock}}\\ =\frac{\$54,000}{35,000\text{ Shares}}\\ =1.54\end{array}$ (6)

To determine

Explain the manner by which stock dividend will be compared to case C if company issues a 30% common stock dividend on the outstanding shares and if  the market value per share is $24.

Explanation of Solution

Schedule of Comparative Differences
Item	Amount of Dollar Increase (Decrease)
	Cash Dividend – Case C	Stock Dividend
Assets	There is a decrease in the value of cash by $90,000.	No change
Liabilities	The liabilities increase by $90,000 when cash dividend is declared and it decreases during the payment of cash dividend.	No change
Stockholders’ equity	Retained earnings of the company reduce by $90,000.	Stockholder’s equity will not change on declaration of stock dividend. The retained value gets reduced due to declaration of dividend and there will be equal increase in the value of common stock $\$84,000\left(35,000\times 30\%\times \$8\right)$.

(Table 4)