A company has not paid dividends on its cumulative nonvoting preferred stock for 20 years.Healthy earnings have been reported each year,but they have been retained to support the growth of the company.The board of directors appropriately authorized management to offer the preferred shareholders an exchange of bonds and common stock for all the preferred stock.The exchange is about to be consummated.Which of the following best describes the effect of the exchange on the company?
A)The statute of limitations applies; hence,cumulative dividends of only seven years need to be paid on the preferred stock exchanged.
B)The company should record an extraordinary gain for income determination purposes to the extent that dividends in arrears do not have to be paid in the exchange transaction.
C)Gain or loss should be recognized on the exchange by the company,and the exchange would have to be approved by the Securities and Exchange Commission.
D)Regardless of the market value of the bonds and common stock,no gain or loss should be recognized by the company on the exchange,and no dividends need to be paid on the preferred stock exchanged.

Question

Quizplus · Accepted Answer

Since the preferred stock is cumulative and nonvoting, no dividends have been paid for 20 years. The board of directors authorized the exchange of bonds and common stock for all preferred stock, signaling the end of preferred stockholders' interest in the company. The company should not recognize a gain or loss on the exchange, regardless of the market value of bonds and common stock. The dividends in arrears, up to the date of the exchange, do not need to be paid since cumulative dividends were not paid in the previous years. Therefore, option D is the correct answer.

A Company Has Not Paid Dividends on Its Cumulative Nonvoting