Journal Entries for Preferred Stock Explained

Preferred stock can be a complex investment, but understanding how to record journal entries for it can help you make informed decisions.

Preferred stock is a type of equity that has a higher claim on assets and dividends than common stock, but it typically doesn't come with voting rights.

The face value of preferred stock is the par value, which is usually stated on the stock certificate.

Journal entries for preferred stock are used to record the issuance and retirement of these securities.

When issuing preferred stock, it's essential to record the transaction accurately in the company's accounts. The journal entry for issuance of preferred stock involves crediting the preferred stock account for its par value.

Company A issued 100,000 shares of preferred stock of $30 par value. The par value is credited to the preferred stock account.

If the issue price of preferred stock is different than its par value, the amount representing the par value is credited to the preferred stock account. The rest of the consideration is treated as additional paid-in capital.

In the case of Company A, they issued preferred stock against $1,000,000 in cash and $2,000,000 worth of property, plant and equipment. This means they had a cash consideration of $1,000,000 and a non-cash consideration of $2,000,000.

The additional paid-in capital account will be credited with the difference between the issue price and the par value of the preferred stock.

Dividend Calculation is a crucial step in accounting for preferred stock. The calculation differs between cumulative and non-cumulative preferred stock.

For cumulative preferred stock, dividends that cannot be paid in a given year are carried forward and paid out of subsequent year profits before any distribution is made to common stockholders. This means that if a company cannot pay its preferred dividends in one year, it will have to pay them in the next year before paying any dividends to common shareholders.

In the case of cumulative preferred stock, dividends for prior periods must be paid before any distribution is made to common stockholders. This is in contrast to non-cumulative preferred stock, where dividends are not carried forward.

The amount of profit available for distribution to common shareholders is reduced by the preferred dividends for the current year. For example, if a company has a profit of $500,000 and $300,000 in preferred dividends for the current year, the profit available for distribution to common shareholders would be $200,000.

Here's a table illustrating the difference between cumulative and non-cumulative preferred stock:

Note that the profit available for distribution to common shareholders is reduced by the preferred dividends for the current year, but in the case of cumulative preferred stock, it is also reduced by any unpaid dividends from prior years.

Journal entries for preferred stock are a crucial part of accounting for these investments. They help track the issuance and repayment of preferred stock.

The journal entry for issuing preferred stock is straightforward: debit cash and credit preferred share and paid-in-capital. This increases the equity section of the company's balance sheet.

To illustrate this, let's look at an example: if a company issues $100,000 in preferred stock at par value, the journal entry would be to debit cash by $100,000 and credit preferred share and paid-in-capital by $100,000 each.

The journal entry for callable preferred stock is also relatively simple: debit preferred stock and credit cash. This is shown in an example where a company pays off $3,000,000 in callable preferred stock.

Here's a summary of the journal entries for preferred stock:

Issuing preference shares to raise capital for business operations is a common practice. This type of equity instrument gives the holder certain rights and privileges.

The par value of preferred stock is the value mentioned on the certificate. Companies can issue preference shares over the par value.

To record the issuance of preference shares, the company debits cash and credits preferred share and paid-in-capital. The journal entry will increase the equity section of the company.

The journal entry for issuing preference shares is:

If the issue price of preferred stock is different from its par value, the amount representing the par value is credited to the preferred stock account. The rest of the consideration is treated as additional paid-in capital.

Callable preferred stock can be redeemed by the company at a specified price. The journal entry for redeeming callable preferred stock is debiting preferred stock and crediting cash.

In a 2-for-1 conversion, 100,000 preferred shares are converted to 200,000 shares. This means that for every one preferred share, two common shares are issued.

The credit to common stock account is calculated by multiplying the number of common shares issued by the par value of $10 per share, resulting in a credit of $2,000,000.

Here's a breakdown of the journal entry for a 2-for-1 conversion:

The difference between the par value and the total value of the common shares issued is credited to the additional paid-in capital account.

To record the sale of preferred stock, you'll need to make a journal entry that debits the cash account and credits the preferred stock account and additional paid-in capital account. The additional paid-in capital account is the difference between the selling price and par value of the preferred stock.

For example, if a company sells 50,000 preferred shares at $5 per share, but the par value is only $1 per share, $2 will be credited to the additional paid-in capital account for each share sold.

The journal entry for this sale would debit the cash account by $250,000 and credit the preferred stock account by $50,000, while crediting the additional paid-in capital – preferred stock account by $200,000. This is calculated by subtracting the par value ($50,000) from the selling price ($250,000).

If the company sells the preferred stock at the price of its par value, there won't be any additional paid-in capital in the journal entry. In this case, the journal entry would simply debit the cash account and credit the preferred stock account by the same amount.

Here's a summary of the journal entry for the sale of preferred stock:

This journal entry increases both total assets and total equity by $250,000 on the balance sheet.

Cumulative preferred stock has a provision to recover dividends not paid in future periods, while non-cumulative preferred stock does not carry forward any unpaid interest.

Cumulative preferred stock requires that preferred dividends for the current and prior periods be paid before common stockholders can receive dividends. This means that if a company can't pay the preferred stock dividend in a given year, it must make up for the shortfall in future years.

Non-cumulative preferred stock, on the other hand, doesn't have this provision, so unpaid dividends are essentially lost.

Here's a comparison of the two:

In the case of cumulative preferred stock, if a company can't pay the preferred stock dividend in a given year, it must make up for the shortfall in future years. As seen in Example 2, Company A had $100,000 of preferred dividends that could not be paid in Year 1 and this amount was carried forward and paid out of the next year profits before any distribution was made to common stockholders.