Arrears is defined as an amount of a liability which is past due or has simply not been paid yet. There are generally two types of arrears concerning annuities and loans, and the second is in respect to preferred dividends.
The majority of the time arrears accounting is concerned with preferred dividends as most companies try and make their payments when they are due with respect to a loan or annuity. They occur in dividends when a company issued preferred stock promising a certain percentage payment of the income every year. However, the company does not have to pay the amount that year. However, the amount is put in arrears account until the company does pay the amount. It could be years or maybe just next year, but the amount keeps accumulating until the arrears payment is made. It should also be noted that the company cannot pay common stock dividends until the arrears account has totally been reduced.
Judy has bought $4,000 worth of preferred stock that pays a 10% dividend every year. The total amount of stock outstanding is $100,000. This means that the total dividend amount paid each year by the company is $10,000.
In the first year the company did not make a dividend payment. This means that the company would need to put $10,000 in the arrears account.
If in the next year the company made a payment of $12,000 it would mean that the entire $10,000 in arrears would be emptied, but would fill back up by $8,000 ((10,000 * 2) – 12,000) or the new amount in the arrears account. The payment to Judy would be in the amount of her percentage ownership of the preferred dividends, 4%, times the amount in the amount of dividends paid to date, which is $12,000. Therefore, Judy will have made $480 on her investment thus far.
If in the next year the company empties the arrears account and current payment by paying dividends of $18,000. Judy will have made $720 more with the payment. The new balance in arrears would be equal to zero.