The incremental method to accounting for convertible bonds means that:
A) The proceeds of the bond are allocated on the basis of the relative market values of the straight bond and imbedded stock option
B) The stock option is valued at the difference between the total proceeds of the bond issue and the market value of an equivalent straight bond issue
C) The proceeds of the bond are allocated on the basis of the book values of the straight bond and imbedded stock option
D) None of these answers are correct

Question

Quizplus · Accepted Answer

The incremental method of accounting for convertible bonds involves allocating the proceeds of the bond issue between the straight bond and the imbedded stock option. The stock option is valued at the difference between the total proceeds of the bond issue and the market value of an equivalent straight bond issue. This amount is then recorded as additional paid-in capital on the balance sheet. Option value is only the difference between the proceeds of the bond and the amount that would be paid for a similar bond without the conversion feature. Therefore, option value consists of the present value of the exercise price (the cash that the company will receive for the additional common shares issued as a result of conversion) and any value over and above the exercise price that the market places on the conversion feature.

The Incremental Method to Accounting for Convertible Bonds Means That