A payment in arrears has occurred when a payment is made to a supplier later than the terms of the arrangement under which goods or services were to be purchased from the supplier. The amount in arrears is the amount of the account payable that should have been paid as of the earlier due date.
For example, ABC International is paying off a long-term debt with monthly payments of $1,000. Through an error in the accounts payable department, the February payment was not made, though all successive payments of $1,000 were made. From the perspective of the lender, ABC continues to be $1,000 in arrears for the most recent amount due, since the lender is likely applying each $1,000 payment to the oldest amount due.
Any type of payment that is in arrears may be a sign of financial difficulty that a creditor or investor should be wary of, since it may indicate a deliberate intent not to pay. 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, reduced payment terms, a reduction in credit, or the revocation of credit. A situation where a single payment is in arrears but is then paid is more likely to indicate any of the following causes:
- There was a dispute regarding the goods or services provided
- The supplier did not issue an invoice
- The supplier sent an invoice to the wrong location
- The buyer lost or incorrectly recorded the invoice in its internal systems
- The buyer changed to a new accounting system, and did not record the payable in the new system
An alternative definition of the term is that a payment is scheduled to be paid at the end of a period, rather than at the beginning of a period. If such is the case, a payment in arrears is not a late payment. For example, a salary is typically paid at the end of a payroll cycle for work already performed.
Yet another variation on the concept is when a company delays payment on dividends that are payable under a preferred stock arrangement. These dividends will continue to be classified as being in arrears until such time as the company pays the dividends.