Convertible Bond Questions
Explain the journal entries when the bond is converted into stock.
(1) No cash is received- the bond is paid with stock; (2) Debit the Bond Payable to take the bond off the books; (3) Debit the PREMIUM or Credit the DISCOUNT to take it off the books; (4) Credit COMMON STOCK for the Par Value ** Debits= Credits and label the Credit entry as ADDITIONAL PAID IN CAPITAL. **
The most common conversion feature is:
A bond or part of the bond --> Stock
What is a convertible bond?
A convertible bond allows the investors (lender) to exchange the bond for something else within a given time under any conditions specified in the bond indenture.
Over what length of time should a discount or premium from a convertible bond to be amortized?
Any premium or discount on convertible debt is amortized to maturity as though the bond will be held to maturity. In other words, proceed as though there is not going to be a conversion.
When inducements are paid to investors to convert a security, how are those cost classified?
Inducements are considered an expense incurred in the ordinary course of business.
How should one determine the gain or loss when a bond is converted into stock, given that the stock will likely be trading for a price different than the carrying value of the bond?
No gain or loss is recognized. The difference in book value of the bond is absorbed into Additional Paid in Capital.
How should one determine the gain or loss from the retirement of convertible debt?
The gain or loss is determined as the difference in carrying (book) value and cash paid, as is with any other bond that is retired early. The extra money received from offering a conversion feature that was never used is not recognized.
How is the issue of convertible bonds recorded?
The same as any other bond: 1. Assume that no conversion of the bonds will be occurring. 2. Assume that the value of the conversion feature is zero (even though investors would typically pay more for a convertible bond than one that was not convertible).