Convertible Bond Accounting: Recording Conversion at a Premium

To calculate the correct accounting entry for the conversion of convertible bonds into common stock, we need to determine the number of shares issued upon conversion and compare the market value of the bonds to the par value of the shares issued. Let's use the following scenario as an example:

Sheridan Company has $4,080,000 of 7% convertible bonds outstanding. Each $1,000 bond is convertible into 30 shares of $30 par value common stock. The bonds pay interest on January 31 and July 31. On July 31, 2018, the holders of $1,290,000 bonds exercised the conversion privilege. On that date the market price of the bonds was 105 and the market price of the common stock was $36. The total unamortized bond premium at the date of conversion was $288,000.

Calculations

First, let's calculate the number of bonds converted:

Number of bonds converted = Bonds outstanding - Bonds not converted = $1,290,000 / $1,000 = 1,290 bonds

Since each bond is convertible into 30 shares of common stock, the total number of shares issued upon conversion is:

Number of shares issued = Number of bonds converted * Conversion ratio = 1,290 bonds * 30 shares = 38,700 shares

Next, let's compare the market value of the bonds to the par value of the shares issued:

Market value of the bonds = Number of bonds converted * Market price of the bonds = 1,290 bonds * $105 = $135,450

Par value of the shares issued = Number of shares issued * Par value per share = 38,700 shares * $30 = $1,161,000

Since the market value of the bonds ($135,450) is less than the par value of the shares issued ($1,161,000), there is no gain or loss recorded on the conversion.

Journal Entry

To record the conversion, the following entry should be made:

Debit: Bonds Payable ($1,290,000)Debit: Unamortized Bond Premium ($288,000)Credit: Common Stock ($1,161,000)Credit: Paid-in Capital in Excess of Par ($417,000)

Therefore, the correct accounting entry for the conversion is a credit of $417,000 to Paid-in Capital in Excess of Par.

Conclusion

This example illustrates the accounting treatment for converting convertible bonds into common stock when the market value of the bonds is less than the par value of the shares issued. It highlights the importance of understanding the relevant accounting standards and performing accurate calculations to record the transaction appropriately.