The book value method is a technique for recording the conversion of a bond into stock. In essence, the book value at which the bonds were recorded on the books of the issuer is shifted to the applicable stock account. This shift moves the bond liability into the equity part of the balance sheet. There is no recognition of a gain or loss on the conversion transaction.
The possible line item entries associated with the book value method are as follows:
- Debit the bonds payable account, which eliminates the bond liability
- Debit the premium on bonds payable account (if used), which eliminates the excess bond liability
- Credit the discount on bonds payable account (if used), which eliminates the bond liability reduction
- Credit the common stock or preferred stock account for the amount of any share par value
- Credit the additional paid-in capital for common stock or preferred stock account to record any residual stock amount
For example, a investor elects to convert one bond issued by ABC Corporation with a book value of $1,000 to ten shares of its common stock. ABC has recorded a $100 discount on the bond. Each share of the company's common stock has a $1 par value. The resulting entry is:
- $1,000 debit to bonds payable account
- $100 credit to the discount on bonds payable account
- $10 credit to the common stock account
- $890 credit to the additional paid-in capital account
This entry is made by the issuer of the stock, not the investor making the conversion from bonds to stock.
An alternative approach to recording a bond conversion is the market value approach, under which a gain or loss on the transaction may be recognized.