Definition
The term induced conversions of convertible debt refers to a process whereby an issuer desires to encourage the conversion of debt to equity. Induced conversions typically include a "sweetener" such as additional stock or cash.
Explanation
In order to lower interest costs or reduce its debt to equity ratio, a company's management team may decide to offer holders of convertible debt an additional consideration if they convert their securities into shares of common stock. The additional consideration will oftentimes include a cash "sweetener" or extra shares of stock if bondholders agree to convert their securities in a certain timeframe.
If offered, the inducement should be recorded as an expense in the current period at the fair market value of the consideration provided. Typically, the journal entry associated with this transaction would include a debit to a conversion expense account.
Example
Company A's management team was concerned their bond ratings were going to be downgraded as a result of an increase to their debt to equity ratio. In the fourth quarter of the year, Company A offered holders of convertible bonds the opportunity to convert their securities into shares of common stock at a 10% premium. The offer included $5,000,000 in convertible bonds, along with 220,000 shares of common stock with a current market value of $25.00 and a par value of $0.01 per share.
The journal entry to record the induced conversion would be as follows:
Debit | Credit | |
Bond Conversion Expense: 10% premium | $500,000 | |
Bonds Payable | $5,000,000 | |
Common Stock: 220,000 shares x $0.01 par value | $2,200 | |
Additional Paid-in Capital: 220,000 shares x $24.99 per share | $5,497,800 |
Related Terms
The term convertible bond refers to an indenture issued by a company that is exchangeable for shares of common stock or the equivalent amount of cash. Convertible bonds are considered a hybrid security, since they contain both debt and equity features.
Moneyzine EditorNovember 6th, 2024
The debt to equity ratio is an indicator of the leverage used by a company. The debt to equity ratio is considered a more stringent measure than the related debt ratio, since this metric tells the analyst how much debt is used to finance the company's assets relative to equity.Moneyzine EditorNovember 6th, 2024
The term involuntary conversion refers to the unscheduled termination of property, plant, and equipment's service as the result of an unwanted event such as a fire, flood, or even theft. When the involuntary conversion of assets occurs, the company must compare the assets' original purchase price and accumulated depreciation to the disposition price to determine if there was a gain or loss on the conversion.Moneyzine EditorNovember 6th, 2024
