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On March 31, Ashley, Inc.'s bondholders exchanged their convertible bonds for common stock. The carrying amount of these bonds on Ashley's books was less than the market value but greater than the par value of the common stock issued. If Ashley used the book value method of accounting for the conversion, which of the following statements correctly states an effect of this conversion?
a. Stockholders' equity is increased.
b. Additional paid-in capital is decreased.
c. Retained earnings is increased.
d. An extraordinary loss is recognized.
Explanation
Choice "a" is correct. Under the book value method of exchanging convertible bonds for stock, the book value of the bonds is reallocated to the par value and the additional paid-in capital accounts of the common stock. Thus, stockholders' equity is increased.
Choice "b" is incorrect. Converting bonds to common stock either has no effect on additional paid-in capital (if the bonds' book value equaled the common stocks' par value) or increases additional paid-in capital.
Choice "c" is incorrect. Only the bond accounts and the common stock accounts are affected under the book value method of exchanging convertible bonds for common stock.
Choice "d" is incorrect. No gain or loss is recognized under the book value method.
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