Market Value Method

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

common stock, valuing convertible debt, book value method