 And welcome to the session in which we will discuss convertible preferred stock. What is the big idea of convertible preferred stock? Well, convertible preferred stock is one of many types of preferred stock, such as cumulative, non cumulative, participating, so on and so forth. But the convertible preferred, it has a special features where it gives the holder, not the company that's issuing the preferred stock. The option to convert, to exchange the stock, the preferred stock into common stock, simply put switch teams from being a preferred stock to being a common shareholder. Well, same concept as convertible bonds. So if you learn about convertible bonds, you will see convertible stock is very similar. Why do we need to learn specifically about convertible preferred? The reason is simple. Convertible preferred are considered dilutive securities. What are dilutive securities? Dilutive securities are securities that could be potentially converted into common stock. And by definition, convertible preferred could be converted into common stock. And as a result, it could dilute earnings per share. It means it will bring down earnings per share. Don't worry about this. Just for now, no, it's dilutive security. And when we'll talk about earnings per share, we'll explain with details, with figures, how does that work? Now, why do companies issue those convertible preferred? Well, just like with bonds, you want to appeal to less risky investors. To less risky investors. Why? Because common stock is quite risky. Convertible stock, convertible preferred, it's still risky, but less risky than common. It's even riskier than convertible bonds, but less risky than common. Also, you want to raise money. The company wants to bring money so we can operate the business by delaying the actual ownership dilution. So we want to raise money, but we don't want to give the new owners any saying in the company. So we'll tell them, look, give us the money now by our preferred stock. And if you like the company, if the company makes a profit, you have the option to switch teams and make profit with us as a common shareholder. Now, when we convert those preferred stock, we're going to be using just like with convertible bonds, the book value method. There's no justification to book again or a loss from your own stock, unless of course you are Enron. That's what they did. They will buy and sell their own stock and book again. Now, the best way to illustrate the concept of convertible preferred stock is to actually look at an example. But before we look at an example, I would like to remind you whether you are an accounting student or a CPA candidate to take a look at my website, farhatlectures.com. I don't replace your CPA review course, nor I replace your accounting course. I'm a useful addition. My motto is saving CPA candidate and accounting student one at a time. 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So let's take a look at this example and I'm going to issue the stock first then convert it. So this way you see the process from A to Z and this will be a review for you. Adam Company issued 10,000 of its $10, 6% convert will preferred for 150,000. Simply put, the power value is 10, this preferred stock is paying 6% and we raised 150,000. The conversion rate is for every five preferred, you will get one common stock that has a $2 power value. So let's take a look at the entry at issuance. We're going to debit cash 150,000. We're going to credit preferred stock. The number of shares issued times the power value, which is 10,000 shares times $10 per share is the power value. And what's left is paid in capital preferred 40,000. And basically I want you to see that it's the same as issuing in quote, regular preferred stock. So when you issue it, you basically ignore the conversion feature because the preferred may or may not convert. So you ignore that feature. Now let's assume that they do convert. What's going to happen if they do convert? And we're going to assume they're going to convert everything to common stock. Remember the rate is for every five, you would receive one common stock and the common stock has a power value of $2. Well, when they convert, first you have to remove the preferred stock and it's paid in capital. So we're going to debit preferred stock, debit paid in capital preferred. Now we're going to issue the stock. Well, if we have 10,000 shares, we're going to divide them by five because for every five, we're going to get one common. So we're issuing a new 2,000 common stock. Well, 2,000 common stock times $2 power value. That's going to give us common stock of $4,000. And guess what? The remainder will be paid in capital common stock 136. Once again, notice there is no gain and no loss. You cannot book a gain or a loss from exchanging your own stocks. Now, the holder of the preferred might have enjoyed a gain or who knows, they're not going to convert if they incur a loss. But if they enjoy a gain, that's for themselves to record that gain and book it. But for the company, they cannot have a gain or a loss from exchanging their own stock. At the end of this recording, I'm going to remind you to go to my website, forhatlectures.com, subscribe, work multiple choice questions. Don't shortchange yourself. To learn this, you have to invest a little bit more in your time, maybe a little bit more of additional resources. I don't replace your CPA review course. I don't replace your accounting course. I can help you do better. Give me a chance. Good luck, study hard. And of course, stay safe.