 Hello, and welcome to the session in which we will discuss preferred stock. We looked in the prior session at the variety of ownership interests in a company, and we looked at common stock as well as preferred stock. And we illustrated the difference between preferred and common stock. And this is a summary of what we did earlier. It's important to understand preferred stock in the context of a common stock. When we say common stock, what we mean is regular stock. So we want to say it's not a common stock. We have to be specific. This is when the users will use the word preferred stock. One thing common stock allow you to vote. They're true owners of the company. Preferred stock cannot vote. So they're not really true owners of the company. That's important to know. Common shareholders, common stock bears the ultimate risks of loss and receive the benefit of success. So they are the true owners of the company. They may get everything or lose everything. They receive dividend only if declared versus preferred stock. They will have a dividend preference. Dividend preference is they will get their dividend ahead of the common shareholders and we'll discuss a little bit dividend preference and how to compute the dividend amount in this session. You are not guaranteed anything in case of liquidation for common stock. Well, in case of liquidation preferred stock, they have a priority in case of liquidation in case the company goes out of business. Represent residual value of the company, which is assets minus liability minus what belongs to the preferred belongs to the common. So simply put, the commons are the last people to be paid in case of liquidation, in case of any distribution of profit. So preferred stock is less risky than common stock. They're less risky. However, preferred stock comes in many different forms and this is what we're going to be discussing in this session. Here are some of the forms that common stock comes into. Cumulative, participating, convertible, callable, redeemable. Simply put, the preferred stocks are contract based. What does that mean? It means once someone wants to buy preferred stock, they can agree with the corporation on the terms, on the conditions. So the corporation or the buyer of the stock may impose preferences or restrictions, or restrictions, preferences or restrictions as long as it's not against the state and corporation law. For example, when Warren, this picture is for Warren Buffett, the legendary investor. So when Warren Buffett buys preferred stock, he might impose on the company certain conditions. For example, when he bought the shares of Bank of America, when he saved Bank of America from bankruptcy, he asked to buy preferred stock. So he wanted to contribute money, but he wanted preferred stock. So when he purchased the preferred stock, he put certain conditions on the company, certain preferences that he wanted to have and obviously they gave it to him. For example, a dividend yield they want. He wanted to be paid a certain amount of money. He wanted to have the option to buy Bank of America common stock at a certain price, so on and so forth. And he then made billions of dollars from that deal. The best way to start this concept is to illustrate a scenario of how to issue and how to compute the dividend for a preferred stock. So let's assume Farhat Lectures issue 1,000 shares of its $100 power value, 6% preferred common stock for $130 for each share. So we sold 1,000 shares at 130 each. We're going to be receiving in cash $130,000. Then we're going to credit preferred stock. How much do we credit preferred stock, just like common stock? We credit preferred stock for 1,000, which is the number of shares, times the power value of the preferred happens to be $100. So we credit preferred stock $100,000. Then anything left is paid in capital in excess of preferred stock, which is $30,000. This entry is also a plug, just like the entry in the common stock. The preferred stock will have also a paid in capital preferred stock. Now what's important in here is to learn and please take a note of how to compute the dividend, because this is going to become handy when we compute the book value per share, the earnings per share when preferred stocks are involved. So the preferred stock pays dividend for this one, $6 per share. How? You will take the power value preferred, which is $100, times the stated rate of 6%. Now some preferred stock, some preferred stock, they will give you the dividend amount. In other words, they will tell you we're paying $6 dividend per share, not a stated rate, not 6%. Or they will tell you $3. They'll give you the number, the amount. So that's the difference. Now, as we mentioned, there are many types of preferred stock. We would like to discuss them all, starting with cumulative preferred, because cumulative is very important to understand because it's going to involve when we compute the book value per share, as well as earnings per share. Before we discuss the cumulative preferred stock, I would like to remind you whether you are a student or a CPA candidate. Take a look at my website, farhatlectures.com. My motto is saving CPA exam candidate an accounting student one at a time. I provide resources, lectures, multiple choice to help you understand the material better. I don't replace your CPA review course. What I do is I organize my material by course and by chapter. So it's very easy to follow in your college accounting courses. My CPA material is aligned also with your Becker, Wiley, Roger, Gleam. So it's very easy to go back and forth between my material and your CPA review course. I offer 1,500 with detailed explanation, previously released AI CPA questions. So if you're studying for your CPA exam, you really don't want to miss this. Also, if you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendations. Like this recording, share it with other connected with me on Instagram, Facebook, Twitter, and Reddit. So what are cumulative preferred? Well, it's when the corporation is responsible for paying what we called any dividend in arrears. What is dividend in arrears? Well, dividend missed in prior years. What is that? Well, sometimes the company might not make a profit for several years. For example, year one, no profit. Well, the dividend comes out of profit. Well, if there's no profit, there's no dividend. Year two, no profit. Well, if there's no profit, we cannot pay dividend. Year three, a lot of profit. Now what's going to happen? If the preferred stockholders, if the preferred stockholders, they have a cumulative preferred, then what's going to happen? You're going to have to pay them for year one. You're going to have to pay them for year two. You're going to have to pay them for year three before you pay anything to the common shareholders. So the preferred dividend is good. It's very profitable for the shareholders. It's not a liability. Although any dividend is missed is not a liability because remember, dividend is not a liability till declared. So if the board of directors does not declare it, it's not dividend. And if they don't have the money to pay, if they don't have the profit, they will not declare it. Again, I'm repeating myself. This topic is important for the book value per share as well as when we compute earnings per share. Now, if we have a cumulative, it means we have non-cumulative. And what's non-cumulative? Well, if we happen to miss year one and year two, because we did not have a profit and we happen to have a profit in year three, we only pay a year three, forget about year one and year two. So non-cumulative is not attractive. It's not marketable to shareholders. It's not marketable to shareholders. People don't like it. They prefer cumulative. Another two types of preferred stock are convertible and callable. And a lot of students confuse the two. So hopefully I can put them side by side and it will be a little bit clearer. It's convertible by the investors. What do we mean by convertible? It means the shareholder, the preferred stock shareholder can exchange it for common stock. How do they exchange it? It's some predetermined ratio, like predetermined ratio, one to five. So if you have one preferred, we'll give you 10 common. Or for every 10 preferred stock, we'll give you one common stock. Whatever that ratio is, this is attractive. This convertible feature attract investors who are hesitant to buy risk, which is common stock. Because common stock is riskier. It's the riskier type of ownership. If you're not sure you want to go all the way in, you will buy a convertible preferred. You will get your dividend. Then, if the company does well, you will convert into common stock. If not, you will keep your preferred. It's a cheaper way. It's cheaper for the company to raise money. Why? Because they're giving you an additional feature. Therefore, they offer a lower dividend rate. So it costs them less money. So this is the convertible. This is convertible by who? Convertible by the investors. We also have a preferred stock that's callable. Callable by the corporation. It means the company at any time have the right to buy it. Again, at a predetermined price. That price could be, usually, it's a premium price. More than what they sold it to you, because that's how they entice you to buy it in the first place, because they tell you, at some point, we want our preferred stock back, but we'll pay you a premium. So they will entice you. Now, why would they do that? Well, because they no longer want to pay the preferred dividend. So that's why they buy it back. Also, if there's any dividend in a year, they'll have to pay it if they're going to call back the stock. And why is this important? Again, because when we talk about the book value, we need to understand this. Now, callable is riskier. It's riskier. Why riskier? Because if you are the holder, they can call it back, and you may not have another opportunity to invest your money. It's also costlier for the company, because they want you to take a risk. What risk? The risk is they buy it from you at any time. If they give me the money back and interest rate is down or the market is down, well, there's not much I can do with my money. So it's costlier for the company and riskier for the preferred shareholder. So it's not, you know, obviously from an investor perspective, an investor would prefer a convertible stock. Also, another two type of preferred stock are participating and redeemable. What is participating? Participating means they share proportionately with common shareholder and profit distribution beyond the stated rate. If you remember when we issued earlier, we issued a $100 par value, 6%. And what I told you is this bond pays $6 per share or the rate is 6%. Well, the participating preferred, it's not only you will get the 6%, if it's participating fully preferred, not only 6%, you would receive the same rate. You'll have to compute what rate our common stockholder is getting and you'll get the same rate as them. So you are not limited. You are not limited in your earnings from this preferred stock, which is good. It means that the company makes a lot of money and they distribute some money to the common shareholder. You can get more than 6%. Again, this topic will be covered later in the book value per share. Redeemable. Redeemable preferred acts like a liability. Redeemable means the shareholder can redeem, can cash the stock, take the stock back, please give me my money, redeemable. If redeemable is the feature and the redeemable is mandatory, it means you have to redeem it at a certain price. It becomes a liability. The new tree that preferred stock has a liability. Now, how should you learn about all these topics? Go to farhatlectures.com. Work additional multiple choice questions. Look at additional exercises to get better. At the end of this recording, I'm going to remind you whether you are a student or not. My material is organized as your college accounting courses, lectures, exercises, multiple choice to help you understand and do better. And if you're studying for the CPA exam, my modules are aligned with your CPA review course. So it's easy to go back and forth once you are stuck on a topic. Use farhat as a supplemental material. Good luck. Study hard. The CPA exam is worth it. Study hard.