Why are dividends in arrears are not considered a liability?
Dividends in arrears are not considered a liability because they do not meet the definition of a liability under accounting standards. In order to be classified as a liability, an obligation must arise from a past event, and the entity must have a present obligation to transfer economic resources.
When it comes to dividends in arrears, they represent obligations to pay dividends that have been declared by the company's board of directors but have not yet been paid to shareholders. However, these obligations do not meet the criteria of a liability because they do not arise from a past event.
To better understand why dividends in arrears are not considered a liability, let's consider the following steps:
1. Definition of a liability: Under accounting standards (such as Generally Accepted Accounting Principles or International Financial Reporting Standards), a liability is defined as a present obligation of an entity, arising from past events, where the settlement of the obligation is expected to result in an outflow of economic resources.
2. Past event: To classify an obligation as a liability, it must arise from a past event. In the case of dividends in arrears, they represent amounts owed to shareholders for dividends that have been declared in the past.
3. Present obligation: A present obligation implies that the entity has a legal or constructive obligation to transfer economic resources. However, in the case of dividends in arrears, the company does not currently have a legal or binding obligation to pay these dividends until they are actually declared and approved by the board of directors.
4. Future event: Dividends in arrears represent a contingent liability, meaning that they may become actual liabilities only if and when the company's board of directors approves their payment. Until that moment, they remain as a potential future obligation, and hence, do not meet the criteria to be recognized as a liability.
In summary, dividends in arrears are not considered a liability because they do not meet the definition of a liability under accounting standards. They represent potential future obligations, contingent upon the approval and declaration of dividends by the company's board of directors.