 Hello and welcome to the session in which we will discuss convertible bonds when you think about convertible bonds The first thing should come to your mind is Tesla Tesla is the poster child of convertible bonds And I will show you why in a moment. So what is the big idea of convertible bonds? Well, simply put the bondholders the people that lend money to the company. They have the right Not the obligation to exchange basically switch teams Switch the bonds into stocks at a given ratio and sometimes they might have a restrictive period For example, you have to wait two three four five six years But at some point you will be able to Give us your bond if you choose and will give you instead a certain amount of stocks So simply put when you invest in a bond you are buying the bond plus you are buying a convertible feature Now what why do we need to learn about convertible bonds? Well because convertible bonds are considered Dilutive securities what are dilutive securities dilutive securities are securities that could potentially decrease earnings per share it means if The bondholders do convert what's going to happen the number of common stock will go up As a result earnings per share will go down because now you need to distribute the profit to more shares We'll talk about this EPS later I just want you to understand what is dilutive securities and you need to understand that convertible bonds are dilutive now Why do companies like Tesla offer those type of bonds? Well, one thing is raise money at a low interest rate and let me show you test what Tesla did Tesla just kind of to give you an idea how much at what rate they were borrowing money by issuing convertible Bond Tesla was able to get away with offering its investor a low coupon a very low coupon For example, they were borrowing money for seven years in February 2014 That's maturing March 1st 2021 offering investors one point two five and its five-year convertible was even offering the investors Point two five percent practically they were paying investors zero Practically point two five is practically zero if you ask me for a five-year borrowing so simply put you give your money to Tesla in 2014 and They pay you point two five However, the deal with Tesla was once that bonds mature the convertible feature will kicks in So the reason is they want to raise money at a low rate. That's one reason and ties potential investors Guess what? You don't want to buy our stock now. Just we're gonna give you a chance to buy it later We're gonna entice you by giving you this option to switch Also when we sell bonds, we don't give up control the company don't give up control Simply put the current shareholders don't give up more control than necessary and this is what Tesla did they raise the money in 2014 use the money to produce cars At the same time the current shareholders did not give up any ownership from an accounting perspective We need to deal with three issues when it comes to convertible bonds when we issue them when we convert them And that could include inducement and when we retire them Now the good news about if you're a Tesla holder Let's assume you did buy those shares those convertible shares and you are getting point 25% which is a very very low yield practically nothing if you did hold them You would realize an 800% profit by March 1st 2021 when those bonds mature Simply put if you invested a dollar you made $800 and let me tell you this is a great investment So the individuals Institutions that did take that deal did a great, you know made really great 800 percent It's a lot of return basically if you invested a thousand two thousand five thousand dollar multiplied by 800 percent And you will see the effect think about investing fifty thousand or a hundred thousand But that's beside the point now the next thing we're gonna do is we're gonna start to look at the accounting aspect of convertible bonds But before we look at the accounting concept of convertible bond I would like to remind you whether you are a student or a CPA candidate to take a look at my website farhat lectures calm I don't replace your CPA review course. 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Those are actual CPA exam questions I kept them in their original format with detailed Solution if you have not connected with me on LinkedIn, please do so take a look at my LinkedIn recommendation Like this recording share it with other connect with me on Instagram Facebook Twitter and reddit So the best way to learn about convertible bond is to actually look at an example Let's assume Adam company issues 1,000 bonds and each bond is a thousand dollar Those bonds are convertible into into the company one dollar one dollar par value common stock at a rate of five stock for each bond So we issued 1,000 bond and each bond can be converted into five Stocks the bonds were issued originally at 103 or 103% it means it was it was issued at a premium Let's take a look at the journal entry when we issue the bond cash 1,000,000 and 30,000 which is a million dollar because we're issuing 1,000 bonds Each bond is a thousand dollar times 103% We're gonna credit bonds payable a million dollar. That's the face value of the bonds and we have a premium of 30,000 so notice it's like issuing a regular bond. We don't care about the convertible feature We simply ignore the convertible feature when we issue the bond now Let's assume the bond holder convert Let's assume one person bought these bond converted the bond when the remaining and amortized premium was 10,000 So the bond holder decided to convert those bond convert convert those bonds What do we have to do? Well, if we convert the bond we have to remove the bond and we have to remove any remaining premium Let's do that. So we debit the bond we debit the premium What's gonna happen in return the company will have to issue the stocks. Well for each bond you issue five stocks We're gonna be issuing 5000 stocks 5000 stocks the par value is a dollar 5000 times a dollar we credit common stock for 5000 and the remainder will be 1,000,000 and 5000 That's a plug basically paid in capital notice. We did not recognize again, nor we recognize a loss on the conversion Now the the the holder of the bond the bond holder That's a different story whether they experience again or a loss. That's a different story But the company itself we don't have a gain or a loss and we call this the book value method simply put We're not going to record again or a loss from exchanging our bonds into stocks. Let's assume instead Adam offered the bond holder a sweetener of 70,000 dollar to convince that bond holder We're gonna assume it's one bond holder or many it doesn't matter to convert. So what happened is sometimes the company will we would want the The bond holder to all the bond holders to convert What do we do with that? I'm look if you convert will give you some extra cash. Now, why do we do that? Why do companies do that sometime is because they don't want to keep paying the interest They want the bond holder to convert. So what do you do? You convince them? You convince them how offering them an incentive cash So here's what's gonna happen the retirement will be the same So it's the same way we retired the bottom say same way they convert the bond they convert the bond and you have to understand that Inducement we have to pay that additional 70,000 it will be counted as an expense simply put all what you need to know We expense the inducement if that's the case. It's an expense Well, let's see what happened if Adam purchased the bonds for one oh two one hundred and two percent Well, if that's the case We're gonna have to figure out whether we have a gain or a loss But at the same time we have to remove the bond because we bought back the bond So we have to debit the bond credit a debit the bond payable debit the premium to remove the bond and we paid 100 a 1 million and 20,000 now we have to find out whether we have a gain or a loss Well, how do we do that? Well the face value of the bond is a million The an amortized amount is 10,000 So the carrying value of a premium bond is 1 million and 10,000 you need to know how to compute the carrying value of A premium bond now we paid 1 million and 20 for a bond that's worth 1 million and 10 Well, the difference is 10,000 so we have a loss at 10,000 now the premium and the loss that happens to be the same It's a coincidence. They have they're not related to each other What you need to understand is this any price paid above 1.01 is a loss because any price paid above 1 million and 10,000 Adam company will have a loss Now, what's the best way to learn more about this go to farhat lectures calm work multiple choice questions Look at additional resources Invest in your CPA invest in your accounting career. Don't shortchange yourself. I can help you do better Good luck study hard. Give me a chance and stay safe