Question

Wood Co.'s dividends on noncumulative preferred stock have been declared but not paid. Wood has not declared or paid dividends on its cumulative preferred stock in the current or the prior year, and has reported a net loss in the current year. For the purpose of computing basic earnings per share, how should the income available to common stockholders be calculated

Answer 1

Once the preferred dividends have been declared, they must be included in the calculation for the earnings per share (EPS) formula: EPS = (net income - preferred dividends) / average shares outstanding.

When the dividends are declared the following journal entry must be made:

Dr Retained earnings X

Cr Preferred dividends payable X

Net income is reported using the retained earnings account, and once the retained earnings account decreases, the preferred dividends become a liability.