When preferred stock is converted to common stock
A) The debt-to-equity ratio decreases.
B) The debt-to-equity ratio increases.
C) The debt-to-equity ratio is unchanged.
D) A gain or loss is reported in earnings for the difference between the fair value of the common stock and the book value of the preferred stock that was converted.

Question

Quizplus · Accepted Answer

Preferred stock is part of shareholders' equity, so when it is converted to common stock, there is no change in the total shareholders' equity. Therefore, the debt-to-equity ratio (which is calculated by dividing total debt by total shareholders' equity) is also unchanged. The gain or loss related to the conversion is recorded in the stockholders' equity section of the balance sheet, not in earnings.

When Preferred Stock Is Converted to Common Stock