Final answer:
Preferred dividends in arrears should be recorded as a liability in the balance sheet. This reflects the company's obligation to pay the dividends at a later date.
Step-by-step explanation:
Preferred dividends in arrears should be recognized as a liability in the balance sheet. These are dividends that have been declared by a company but not paid to preferred shareholders. They represent an obligation to pay the dividends in the future, and therefore should be recorded as a liability.
For example, if a company declares preferred dividends of $1 million but only pays $500,000 in the current period, the remaining $500,000 would be considered dividends in arrears and should be reported as a liability in the balance sheet.
This treatment is consistent with the accounting principle of accrual accounting, which requires recognition of obligations as they are incurred, rather than when the payment is actually made.