 Hello, and welcome to this session. This is Professor Farhad. In this session, we would look at dividend preference and the book value per share. In a sense, they are related and you will see how in a moment this topic is covered in intermediate accounting as well as the CPA FAR section. As always, I would like to remind you to connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1500 plus accounting, audit, finance, and tax lectures. This is a list of all the courses that I cover, including CPA questions. On my website, you have access to additional information such as PowerPoint slides, notes, exercises, 2000 plus CPA questions. So let's go ahead and talk about dividend preference. So what is dividend preference? Well, first of all, who get the dividend preference? Only the preferred shareholders. Simply put, the preferred shareholders in contrast to the common stockholders, they get their money first. They get their dividend first. So let's go ahead and work an example to see how the dividend preference works. So let's assume in 2017, M company is to distribute 50,000 shares as cash dividend to its outstanding common stock, have a par value of 400,000, and to its 6% preferred stock that has a par value of 100,000. Now before we proceed, there's an important term here we need to be familiar with, the preferred dividend, they know how much they're going to be getting per share. The dividend rate is stated. So this is the dividend rate. So they know they're going to be getting 6% per par value, which is $100,000. What does that mean? It means every time we pay dividend, the preferred shareholders get their money first, which is 6% of 100,000. They get paid $6,000. What does that mean? It means if we're distributing $50,000, $6,000 will go to the preferred and the remaining $44,000 will go to the common. So if the preferred is non cumulative and non participating, which is simply put, it's the regular preferred, here's what's going to happen. $6,000 will go to the preferred and what's left is $44,000. $44,000 goes to the common. So simply put, the preferred gets $6,000, the common get $44,000. So this is a dividend, a preferred dividend that's non cumulative and non participating. Now we're going to take this example. So if you don't have the PowerPoint slides, copy this data down. So we have just going to just want to let you know we have 400,000 of common stock and we have 100,000 of preferred stock and those preferred stock are paying 6%. Let's take a look. Let's change the scenario a little bit. Same scenario. Let's assume the preferred is cumulative, but non participating and Mason did not pay dividend on the preferred in the preceding two years. So in this situation, we have a preferred situation, which is cumulative cumulative means if we owe you any prior years, we have to pay you those prior years first. And we are they're telling us we are two years behind. Well, what does that mean? We have $100,000 and preferred stock times 6%. So every year we are responsible for paying $6,000. $6,000 times 12 times two equal to 12,000. So this is what we call dividend in a year. Okay, so this is for the prior two years. Now we have to pay the current year, which is also $6,000. So simply put, the preferred get 12 plus six, which is 18. And what's left of the 50. So this is the $50,000 18 goes to the preferred and 32 to the common and $12,000 for the prior years, $6,000 for the current year, anything left goes to the goes to the goes to the common. Okay, let's change the scenario a little bit. Again, we're working with the same scenario. Now let's assume that the preferred is non cumulative, but it's fully participating. Now we have to understand what's fully participating. Fully participating means the common and the preferred, they shared the same rate. What is the rate? Well, the rate is 6%. Remember, the rate is the 6% because the common don't have a rate. What does that mean? It means first, we're going to pay the preferred, the preferred shareholders, they're going to get 100,000, the power value times 6%. They get $6,000. The common shareholders, they're going to be sharing, participating using the same rate times 6% equal to 24,000. So the first thing is from the 50,000. So from the 50,000, we're going to distribute now 6 to the preferred and 24 to the common. That's the first stage. Now guess what? If we paid 50, guess what? We still have $20,000 to distribute. How are we going to distribute the $20,000? Here's what's going to happen. We're going to have to find the rate for the, we have to find the participating rate. How do we find the participation rate? Well, we're going to take this amount, what's left, $20,000 and we're going to divide it by the total equity, common and preferred. Common and preferred, we have preferred $100,000 and common $400,000. So $20,000 divided by half a million, that's going to give us 4%. What does that mean? It means for the remaining 20%, 4% goes to the preferred and 4% of the remaining goes to the common. What's left is 20,000 times 4% and I'm sorry, 20,000, 100,000 times 4% and 400,000 times 4%. So for the first is 4,000. For the second allocation is 16,000, total of 20,000. So let's go through the second allocation. So simply put, 4,000 goes to the preferred, 16,000 goes to the common, total 20. So 4,000 to the preferred, now the preferred have 10,000 in total and the common has 40,000 in total and we distributed in total $50,000, $50,000. Let's change the scenario a little bit, again the same sets of data and let's assume if the preferred is cumulative, it's accumulative and fully participating now. So it's accumulative and fully participating. Well, if it's cumulative and fully participating, now we have to find out if we are any, if we owe them any year, any prior years, well the preceding two years we owe them. Well, what does that mean? Remember for every year 6,000, therefore up front we have to pay them $12,000 for the two preceding year. Then we have to pay, remember after we paid the $12,000 from the prior example, we pay $6,000 for the preferred and $24,000 for the common and that's based on the 6% rate. Then what's left now, let's see how much left. So we have $50,000 because now we have to find the new participating rate, minus $12,000 for the preceding two years, what's called dividend in a year, minus $6,000 for the preferred, minus $24,000 for the common. What's left is 8, oops, let's wait, that's left is $8,000. Now we're going to take the $8,000, divide the $8,000 by half a million, which is the common and the preferred, and we'll get a $1.6 participating rate. Now the $8,000, we're going to take the $8,000 times 1.6, I'm sorry, I always do this, $100,000 times $100,000 times 1.6 and $400,000 times 1.6%. So this is the preferred share and this is the common share. Let's take a look at the math now. $12,000 for the preferred, we have to pay them first up front before we do anything. Then the participating rate is the first allocation is 6%, 6% times $100,000 is $6,000, 6% times $400,000 is $24,000. What's left is $8,000, $8,000 divided by half a million give us a rate of $1.6, $1.6 times $1,000 is $1,600, $1.6 times $400,000 is $6,400. Now this is the total for the preferred $19,600, the total for the common $30,400. Now the next thing we're going to look at is the book value per share. Now what is the book value per share? Here's what I want you to think of the book value per share. Look at the, look, we have assets, we have assets equal to liabilities plus equity. Now theoretically everything in the equity, everything in the equity belongs to the common share holders. Everything in the equity because the equity is the net asset is the ownership. So everything in the equity belongs to common shareholders unless, unless I'm going to change the color, unless we have preferred stock. If we have preferred stock, we have to deduct anything that related to the preferred. And what's, what's anything related to the preferred, the preferred itself minus any dividend we owe the preferred or any dividend in a rear or if there's a call price for the preferred. Okay. And anything left, so total equity minus the preferred related is what's left for the common shareholders. It's what's left for the common shareholders. Let's work an example to see how this work. Okay. So the book value per share is computed as the net asset, net asset is assets minus liability or equity divided by outstanding stocks. The computation becomes more complicated if the company has preferred stock. It's not really more complicated. We just, we have to take the preferred stock into account, deduct the preferred stock. So let's take a look at an equity section. And here's an equity section. Here's the total stock holders equity. And the total stock holders equity is 900,000 82 dollars, which is the total preferred minus plus the common stock. Okay. The common, remember the common, the common has common stock, everything else except the preferred retained earning everything else goes to the common except the preferred. Okay. What does that mean? It means this, this is what belongs to the common, because this is the preferred. This is the preferred component. So this is total equity 900,000 82 is total equity, but we have to deduct from total equity 300,000. What's left for the common is 600,000 and 82 dollars. Well, if we have, if we have 4,000 shares, well, we'll take 600,000 82 dollars, 600,000 82 dollars divided by 4,000 shares and the book value per share equal to 150.02 150.02. So this is how we compute the book value per share. Now, what does it mean the book value per share from a business perspective? It means based on the book value of the company book value means, means based on historical cost based on the accounting record, the company is worth $150.02. Now, in the real world, so this is just in the real world, what happened is this there is a measurement that basically you will take the book value of the stock and you multiply it by a number by a multiple like five. Okay, by five, and you will find the fair market value, find the approximate fair market value. For example, for restaurant business of their book value is $20. The stock price should be $80. We multiply it by four. I'm just giving you an example. So this is how the book value is used. It's basically the value of the company. So this is how much each stock is worth today based on the accounting record. It's the book value. The book value is the accounting record. Now, the higher the better assuming you have, you know, your fair market value is a multiple of the book value. Okay, let's take a look at maybe one more example. Now assume the same fact except that the 5% preferred is cumulative. Now, the preferred is has a 5% rate is cumulative, participating up to 8% and that the dividend is three years in a year. So now we have the preferred, we're going to assume that the preferred here, let me go back here, so it is 5%. So we're going to assume is this this 300,000 is cumulative. First of all, first of all, let's find out how much do we have to pay per year. Per year is 300,000 times 5%. 300,000 times 5% is 15,000. So we have to pay per year 15,000. Now what happened is this, now we are three years behind. So for the dividend in a year, we owe them 45,000. Then we have to pay them 15,000 for this year. Okay, we have to pay them 15,000 for this year. Okay, what else do we have? What else are we told in this problem? And it's fully participating, fully participating. Fully participating means they're going to be getting an additional, actually, they're giving us the rate. Fully participating, up to 8%, up to 8% means we're going to pay them an additional 3%, because 5 is the regular rate, up to 8%. They can get up an additional 3%. Well, what is an additional 3%? 300,000 times 3% is 9,000. Again, this also goes to the preferred. Okay, this goes to the preferred. So we have the dividend in a year 45,000, current year dividend, and the participating 9,000. And the dividend itself is 300,000. Okay, now what does that mean? It means, remember, we have, let me erase this, we have total equity. Let me change the color back here. We have total equity. Remember, our total equity is 900,082 dollars. What we have to do now is deduct all of those, all of those in what's left is the common share. What's left is the common share. This is what we have to do. So what does that mean? It means it's the 300,000 plus 45,000 for the dividend in a year at a rate of 5%, current year 5%, 3% participating. So all of those, so 300,000 plus those figures equal to 369. Now, remember, when we take 900,000 and 82 dollars, minus 369,000. Let me just make sure this is correct. So 900,000 minus 369. Yeah, well, I did not use the 82. Yes, it's 531,82. It means this is the amount the net amount that belongs to the common share holders. Now, we'll take this amount divided by 4,000 shares. Obviously, the book value goes down. Why does the book value goes down? Because the preferred, we owe them more money. That's why the book value will go down. The book value is 132 dollars and 77 cents. Now, if you have any questions about this topic, please email me. 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