Arrears definition

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What is Arrears in Accounting?

In general, the term arrears means that something is late in being paid. For example, a debt payment could be in arrears, as could an account payable to a supplier, or a bond or interest payment to investors. In all of these cases, a company may enter into negotiations to revise the underlying debt agreement, either to reduce the amount or prolong the term of the payment.

Any type of payment that is in arrears is certainly a sign of financial difficulty that a creditor or investor should be wary of, but a continuing pattern of payments in arrears will likely trigger some sort of restrictive action, such as calling a loan early, an increase in the interest rate charged, or a reduction in credit.

Example of Arrears

For example, a borrower is required to make a $1,500 loan payment no later than March 21, but forgets to make the payment. As of the following day, the borrower is in arrears in the amount of the missing loan payment. If the borrower continues to make loan payments in all successive months, he is still in arrears for the $1,500 loan payment until he remits it to the lender.

For a variation on the example, what if the borrower were to only send in half of the loan payment? This means that he would still be in arrears for $750 until he pays off this amount.

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Cumulative Dividends in Arrears

Most commonly, arrears refers to a situation where a company has preferred stock outstanding, the stock has a cumulative dividend feature, and the company is unable to pay the dividend. A cumulative dividend is a dividend that remains a liability of the company until such time as it pays the dividend. During the period when the company is liable for the dividend but has not yet paid it, the dividend is said to be in arrears.

While the dividend is in arrears, the legal agreement associated with the preferred stock usually prevents the company from issuing any dividends to common stockholders, and may possibly contain additional restrictions on its use of cash. Further, the company must disclose the amount of the dividend in arrears in its financial statements.