Convertible Debt
If convertible debt is ITM and it gets converted, you wipe out the debt on the B/S but how do you determine how much to add onto Shareholder's Equity? Thanks everyone!
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Each bond has a conversion ratio which specifies how many shares you get when you convert a bond. Let's say the ratio is 19:1, that means you can convert 1 bond into 19 shares. If shares are currently trading @ $50 then you would exercise the in the money CB into 19 x 50 = $950 worth of equity.
How does that balance the B/S upon conversion??
Not 100% sure but it should be balanced out by positive or negative retained earnings, paid in capital and adjustments to net income on income statement.
It balances because you are essentially taking the debt out of the liabilities section and moving it to the equity section. To take sharpie's example further:
I'm going to assume that the convertible bond's face value is $100. When you exercise the conversion, you have to take into account the par value of the stock. Let's say it's $2. So when you convert 19 shares you increase (credit) common stock by $38. Then you need a plug figure to balance out the transaction. In this case you would credit Paid in Capital in Excess of Par (an equity account) for $62. So you can see that you are simply moving around the source of capital within the L+SE section of the balance sheet.
I may have messed up a couple details because it's late, but it looks right to me. Let me know if the explanation doesn't make sense.
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