Understanding Bond Retirement by Conversion

Bond Retirement by Conversion

Holders of convertible bonds have the right to convert their bonds to stock. When conversion occurs, the bonds’ carrying value is transferred to equity accounts and no gain or loss is recorded. (We further describe convertible bonds in the Decision Analysis section of this chapter.)
To illustrate, assume that on January 1 the $100,000 par value bonds of Converse, with a carrying value of $100,000, are converted to 15,000 shares of $2 par value common stock. The entry to record this conversion follows (the market prices of the bonds and stock are not relevant to this entry; the material in Chapter 13 is helpful in understanding this transaction):

 
 

Decision Insight
Junk Bonds Junk bonds are company bonds with low credit ratings due to a higher than average likelihood of default. On the upside, the high risk of junk bonds can yield high returns if the issuer survives and repays its debt. ▪