The financial accounting term valuing convertible debt refers to the process of determining the cost assigned to these securities at the time of issuance and conversion. While the method used to value convertible debt when issued is similar to that of non-convertible securities, the market value or book value approach can be used at the time of conversion.
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 this transaction when first issued and when the holders of these securities convert them into shares of common stock. An overview of the two acceptable approaches to valuing this transaction is as follows:
Companies are also required to make certain disclosures on their financial statements. For example, the notes to the balance sheet should include the principal amount of the liability, its unamortized discount, and the net carrying amount. The notes to the income statement should include the effective interest rate for the liability and the term over which amortization of a discount or premium occurs, the conversion price and the shares to be delivered when converted.