Convertible Bonds

Question 1

What is the purpose of a convertible bond?

Answer 1

In an effort to increase the marketability of a bond issue, a firm includes a convertibility feature in the terms of the bond entitling the holder of the bond to convert the bond into common or preferred stock

Question 2

When a convertible bond is issued how are the proceeds treated?

Answer 2

As a single selling price, in other words no part is allocable to the conversion feature

Question 3

What 2 methods are allowed in accounting for convertible bonds?

Answer 3

1. ) Book Value method - Upon conversion the remaining BV of the bonds (FV plus unamortized premium or less unamortized discount) is trasnferred to capital stock account and contributed capital in excess of par account. No gain or loss is recorded.
2. ) Market Value method - Upon conversion the MV of the stock or bond is allocated to capital stock account and contributed capital. A gain or loss is recorded equal to the difference between the total MV recorded and the remaining BV

Question 4

What is the accounting treatment by the issuer for additional consideration paid to induce conversion of convertible bonds?

Answer 4

Recognize expense for the fair value of the additional consideration

Question 5

What is the accounting treatment for convertible bonds with a beneficial conversion feature?

Answer 5

The excess of fair value of the stock to be issued upon conversion (measured at the date of issuance) over the face value of the bonds, is allocated to owners’ equity

Question 6

What amount is allocated to owners’ equity on issuance of convertible bonds that can be settled in cash?

Answer 6

Issuance price less the present value of the bonds using the prevailing rate on similar bonds

Question 7

An interest rate that is lower than the nonconvertible debt is often associated with what type of securities?

Answer 7

Convertible debt securities