What it means
In the overdue sense, arrears arise whenever a scheduled payment is missed: a tenant who has not paid rent due on the first of the month, a borrower who has missed a loan instalment, a company that has not paid preferred dividends due to shareholders, a customer whose invoice is 30 days past its due date. The amount in arrears is the total of missed payments, and lenders and landlords track both the amount and the age of arrears because the older a debt, the less likely it is to be collected.
For businesses, arrears are watched on both sides. Customer arrears (overdue receivables) tie up working capital and signal collection problems; an ageing report groups them by how long overdue they are and drives the credit control process.
The business's own arrears, to suppliers, lenders or the tax authority, are a warning sign of cash trouble, can trigger penalties and default clauses, and in the case of tax and payroll obligations can carry personal liability for directors. In the timing sense, "in arrears" contrasts with "in advance".
Employees are usually paid in arrears; rent is usually paid in advance. Loan interest is normally charged in arrears, at the end of the period it covers.
Understanding which applies affects cash planning and the calculation of accruals: a cost paid in arrears must be accrued at period end, while a cost paid in advance must be treated as a prepayment. Cumulative preferred shares have a specific arrears rule: if the company skips a preferred dividend, the missed amount accumulates as dividends in arrears and must be paid before any dividend can go to ordinary shareholders.
Those arrears are disclosed in the notes to the accounts but are not recorded as a liability until declared.
In practice
Real-world examples.
Example
A landlord's rent ledger shows a tenant two months in arrears; the tenancy agreement allows the landlord to begin possession proceedings once arrears reach two months.
Example
An employee's contract states that salary is paid monthly in arrears on the 28th, so the January salary covers work done from 1 to 31 January.
Example
A company's ageing report shows $120,000 of receivables more than 90 days in arrears, and the credit controller passes the largest to a collection agency.
Think of it
“Arrears means you're behind on payments-owing money that should have been paid already.
Formula
Calculation
Amount in Arrears = Sum of scheduled payments due to date minus Payments actually made
Days in Arrears = Today's date minus Due date of the oldest unpaid instalment
Worked example 1, a loan. A borrower has a loan with monthly instalments of $1,200 due on the 1st of each month. On 15 May, the payments for March, April and May have not been made.
- Amount in arrears = 3 x $1,200 = $3,600
- The oldest missed payment was due 1 March, so the account is 75 days in arrears
- If the lender charges a late fee of $25 per missed instalment and default interest of 2% a month on arrears, the May statement shows $3,600 of arrears plus $75 of fees plus roughly $108 of default interest (2% of $3,600 for 1.5 months)
Worked example 2, cumulative preferred dividends. A company has 100,000 cumulative preferred shares paying $2 a year. It skipped the dividend in each of the last two years.
- Dividends in arrears = 100,000 x $2 x 2 = $400,000
- Before paying any ordinary dividend, the company must pay the $400,000 of arrears plus the current year's $200,000Case study
Seen in the real world.
A property management company handled 400 rental units and tracked arrears in a spreadsheet updated monthly. By the time a tenant appeared on the report they were often two or three months behind, and the average recovery was under 50%. The company moved to weekly arrears reporting from its property system, with an automatic reminder at three days overdue, a phone call at ten days and a formal notice at 21 days.
It also offered tenants in early arrears a payment plan rather than waiting for the debt to grow. Within a year total arrears fell from 6.5% of rent roll to 2.1%, evictions halved, and the landlords the company managed for received rent on average eleven days sooner. The finding that surprised management was that most arrears were caused by a single missed payment that snowballed, not by tenants who never intended to pay.
Watch out
Common mistakes.
- Confusing "paid in arrears" (normal timing at the end of a period) with "in arrears" (overdue). The first is routine; the second is a problem.
- Letting small arrears age. Recovery rates fall sharply once a debt is more than 90 days old.
- Ignoring the business's own arrears to tax authorities or lenders, which carry penalties and can trigger default on other borrowings.
Questions
People also ask.
What does "paid monthly in arrears" mean?
Payment is made at the end of each month for that month, rather than at the start.
Are dividends in arrears a liability?
Not until they are declared. They are disclosed in the notes and restrict ordinary dividends, but they do not appear on the balance sheet as a debt.
How are arrears shown in a company's accounts?
Overdue receivables are part of accounts receivable, analysed by age in the notes or in management reports. The business's own overdue payments remain in payables, loans or tax liabilities as appropriate.
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