Accounting for Convertible Debt PDF

# Accounting for Convertible Debt ## At Time of Conversion - Companies use the **book value method** when converting bonds. - When the debtholder converts the debt to equity, the issuing company recognizes no gain or loss upon conversion. # Stock Warrants - **Warrants** are a security that gives...

# Accounting for Convertible Debt ## At Time of Conversion - Companies use the **book value method** when converting bonds. - When the debtholder converts the debt to equity, the issuing company recognizes no gain or loss upon conversion. # Stock Warrants - **Warrants** are a security that gives investors the option to purchase a company's stock at a specific price over a specific period. - Warrants are typically included as a "sweetener" to investors to purchase a company's bond issuance. - Investors like warrants because they provide an opportunity to share in the future growth of the company or to sell the warrants in the market. - Companies use stock warrants to reduce the cost of financing (pay a lower interest rate). ## Synthetic Convertible Debt **Formula** Debt + Nondetachable Stock Warrants = Synthetic Convertible Debt ## Stock Warrants Issued with Other Securities - When stock warrants are issued with bonds, the stock warrants may be detachable or nondetachable: - **Detachable**: Warrants may be sold separately from the bonds. - **Nondetachable**: Warrants can only be sold with the bonds. - Nondetachable warrants do not require an allocation of the proceeds between the bonds and the warrants. - Like the accounting for convertible bonds, companies record the entire proceeds from nondetachable warrants as bonds payable. # Dilutive Securities ## Convertible Preferred Stock - **Convertible preferred stock** includes an option for the holder to convert preferred shares into a fixed number of common shares. - Convertible preferred stock is part of stockholders' equity, not liabilities (unless mandatory redemption exists). - Remember, convertible bonds are liabilities, so be careful and do not confuse convertible preferred stock with convertible bonds. # Weighted-Average Shares Outstanding ## Stock Dividends and Stock Splits - When **stock dividends or stock splits** occur, companies need to restate the shares outstanding before the stock dividend or split, in order to compute the weighted-average number of shares. - Companies restate the issuance of a stock dividend or stock split, but not the issuance or repurchase of stock for cash. # Stock Warrants ## Rights to Subscribe to Additional Shares - **Stock Right**: existing stockholders have the right (preemptive privilege) to purchase newly issued shares in proportion to their holdings. - Price is normally less than the current price of the shares. - Companies make only a memorandum entry. - No journal entry is required when a company issues stock rights to existing stockholders. # Determine: 1. Value of the bonds without the warrants, and 2. Value of the warrants. The **proportional method** allocates the proceeds using the proportion of the two amounts, based on fair values. ## Proportional Method - Detachable # Basic Earnings Per Share ## Weighted-Average Number of Shares Outstanding - Weighted-average number of shares outstanding during the period constitutes the basis for the per-share amounts reported. - Companies must weight the shares by the fraction of the period they are outstanding. ## Income Statement Presentation of EPS Components - When the income statement contains intermediate components of income (such as discontinued operations), companies should disclose earnings per share for each component. | Earnings per share: | | | ------------------------ | --------------------- | | Income from continuing operations | \$4.00 | | Loss from discontinued operations, net of tax | \$0.60 | | Net income | \$3.40 | ## Income Statement Presentation of EPS - **Earnings per share** indicates the income earned by each share of common stock. - Companies report earnings per share only for common stock. | | | | ------------------------ | --------------------- | | Net income | \$300,000 | | Earnings per share | \$3.00 | ## Preferred Stock Dividends - Subtract the current-year preferred stock dividend from net income to arrive at **income available to common stockholders**. **Earningspershare = (Net income - Preferred dividends) / (Weighted-Average Number of Shares Outstanding)** - Current year preferred dividends are subtracted on cumulative preferred stock, whether declared or not. ## Earnings per Share - Simple Capital Structure - **Simple Structure**: Common stock; no potentially dilutive securities. - **Complex Structure**: Includes securities that could dilute earnings per common share. - "Dilutive" means the ability to influence the EPS in a downward direction. # Stock Warrants - Two methods are available to determine how much of the proceeds from the sale should be allocated to each security: - The proportional method. - The incremental method.