The term cumulative preferred stock refers to securities containing a feature that requires the payment of passed dividends to preferred shareholders before providing common shareholders with a dividend payment. While it's possible for a company to issue noncumulative preferred stock, these securities would be considered unattractive to investors.
Companies have the ability to attach a number of features or restrictions to the preferred stock they issue to the market. For example, preferred stock can be issued as cumulative, participating, convertible, and callable. These features can add to, or subtract from, the value the security provides to investors.
Nearly all preferred stock issued today has a cumulative feature, which protects the rights of these shareholders to dividends. Specifically, if the directors of the company fail to declare a scheduled dividend, it is termed as "passed." This can happen if the company has difficulty meeting all of its current financial obligations. If the preferred stock has a cumulative feature, the total of all the passed dividends is referred to as "dividends in arrears."
Before a company can provide the shareholders of common stock with a dividend, all of the dividends in arrears must be paid to shareholders of cumulative preferred stock. Finally, when a company fails to declare a scheduled dividend, there is no liability created or recorded on the company's books; however, a footnote should appear in the company's financial statements.