Definition
The financial accounting term market value method refers to one of two approaches to valuing a transaction involving the conversion of bonds to common stock. The market value method uses the current market value of either the company's common stock or the bond when recording the transaction.
Explanation
Companies will issue convertible securities for a number of reasons. For example, convertible bonds and preferred stock may include this feature to attract investors, since the ability to convert these securities to common stock lowers their perceived risk.
When a company issues convertible debt securities, they need to assign a value to the transaction when the holders of these securities convert them into shares of common stock. There are two accepted ways to value this transaction, the market and the book method.
The market value method uses the current price of the common stock or bond to record the transaction. In theory, this is the more sound approach of the two methods. For example, if a bondholder is entitled to five shares of common stock, and the current market price of the company's stock is available, it can be used to value this transaction.
If the current market price of a share of common stock is not available, but the bond's market price is readily available, then it can be used to record the transaction.
Example
Company A's convertible bonds have a face value of $1,000 and a book value of $1,025. Bondholders have the right to convert this security to fifty shares of Company A's common stock, which is currently selling for $22.00 per share. The par value of Company A's stock is $1.00 per share.
The value of common stock provided to the bondholder would be:
= 50 shares x $22.00 per share, or $1,100
Since the bonds have a book value of $1,025, Company A would record a loss of $75 on the conversion. The following journal entry would be used to record this transaction:
Debit | Credit | |
Bonds Payable | $1,000 | |
Premium on Bonds Payable | $25 | |
Loss on Conversion of Bonds Payable | $75 | |
Common Stock | $50 | |
Paid-In Capital in Excess of Par | $1,050 |
Related Terms
The term capital stock is used to describe the authorized and issued transferable units of ownership in a corporation. Capital stock can include both common as well as preferred securities. The value of all capital stock issued can be found on the company's balance sheet.
Moneyzine EditorJanuary 10th, 2024- The financial accounting term valuing convertible debt refers to the process of determining the cost assigned to these securities at the time of issuance and conversion. While the method used to value convertible debt when issued is similar to that of non-convertible securities, the market value or book value approach can be used at the time of conversion.Moneyzine EditorSeptember 21st, 2023
The financial accounting term book value method refers to one of two approaches to valuing a transaction involving the conversion of bonds to common stock. The book value method uses the current book value of the company's bonds when recording the transaction.Moneyzine EditorJanuary 9th, 2024
