Convertible Bonds

Convertible Bonds

bonds that may be exchanged for shares of stock. In theory, a convertible bond may be thought of as a regular bond plus an option on a number of shares of stock.

How does GAAP treat convertible bonds?

dont care for the individual components of a convertible bond, indicates that the entire proceeds from the issuance of a convertible bond be treated as an ordinary bond at the time of issuance SO whenever a convertible bond is issued Cash is debited for amount of proceeds Bonds Payable Credited for the face value of bonds issued and a discount/premium credited for the difference

What are some reasons convertible bonds may be issued?

investors may want the higher security related to investing in a bond but still want to share in the firm's upside potential

Market Value Method

recorded at its market value at the time of the exchange the carrying value of the bonds is removed from the books and a gain or loss is recorded to make the entry balance

What happens when convertible bonds are converted into common stock?

the issuing firm may use either of two methods to record the conversion book value method or market value method

Book Value Method

the stock issued in exchange is recorded at the carrying value of the bonds at the time of the exchange no gain or loss is recored