Torino company has 10,000 shares of $5 par value, 4% cumulative and nonparticipating preferred stock and 100,000 shares of $10 par value common stock outstanding. the company paid total cash dividends of $1,000 in its first year of operation. the cash dividend that must be paid to preferred stockholders in the second year before any dividend is paid to common stockholders is:
1. $3,000.
2. $1,000.
3. $0.
4. $4,000.
5. $2,000.

$3000

Explanation:

Before any dividend is paid to common stockholers, the arrears of dividend due to cumulative nonparticipating preferred stockholders plus the divided for the current year must be paid. As the annual dividend of the preferred cumulative nonparticipating shares is $2,000 (10,000 units x $5 x 4%).

Since payment made last year is $1,000, one will asume this payment is part payment for the $2,000 due to this class of stockholders, thus leaving $1,000 payable to them. The current year also produces a liability of $2,000, thus increasing the amount due to them as $3,000.

The dividend to common stock holders is discretionary and thus does not amount to a liability until the shareholders agree to its payment in the AGM.