Accounting for Convertible Preferred Stock

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Convertible preferred stock is preferred stock which the holder can convert to common stock. Convertible preferred stock has a conversion rate, for example, one share of preferred stock for four shares of common stock.

  • Record the preferred stock when it is issued in the general ledge. The journal entry is:

    Debit - Cash (by the amount of cash collected)
    Credit - Preferred Stock (by the par value multiplied by the number of shares)
    Credit - Additional Paid In Capital (if Cash is greater than Preferred Stock)
    Debit - Additional Paid In Capital (if Preferred Stock is greater than Cash)

    Remember the journal entry must balance, so credits must equal debits.

  • Convert the preferred stock using book value method. The book value method uses the book value of the preferred stock as the amount of conversion. The journal entry for the conversion is:

    Debit - Preferred Stock (the book value of the preferred stock converted)
    Debit - Additional Paid In Capital from Preferred Stock (any paid in capital related to the converted preferred stock)
    Debit - Retained Earnings (use only if the preferred stock and additional paid in capital from preferred stock is less than the common stock)
    Credit - Common Stock (multiply the par value by the amount of converted stock)
    Credit - Additional Paid In Capital (use only if the preferred stock and additional paid in capital from the preferred stock is more than the common stock)

  • Change the financial statements to state the correct amount of issued shares for preferred and common stock. For example, if before conversion a company has 1000 shares of common stock and 1000 shares of preferred stock. A preferred stock holder converted 100 shares of preferred stock to 400 shares of common stock. The stockholders' equity section should now have 1,400 shares of common stock and 900 shares of preferred stock.

References

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