Question

On January 1, 2014, Kevin Corp. issues 5,000 bonds with warrants attached that give the holder the option to buy a share of common stock (par value $1) at some time in the future for $50.

• Each individual bond has a face amount of $1,000 and comes with 10 detachable warrants. The bonds (with the attached warrants) were issued at 103.

• Just after issuance, the bonds alone (i.e., without the warrants) were trading at 97 on the secondary market. At the same time, the warrants were trading separately on the secondary market for $8.

• On June 15, 2017, all of the warrants are exercised.

a) Prepare the journal entry to record the issuance of the bonds with detachable warrants. (14 points)

b) On June 14, 2017, the stockholders’ equity balance is 1,500,000 (credit). What is the balance after the warrants are exercised on June 15 (indicate if it is a debit or credit balance)? (8 points) ______________________________

Answer 1

Answer-a:

Proceed of the issue = $5,150,000

This is allocated based on the relative fair values of the two securities.

The total market value of the two securities after issuance is $5,250,000 ($4,850,000 + $400,000).

The allocation to the bond is then $4,850,000 / $5,250,000 × $5,150,000 = $4,757,619

The allocation to the warrant is $400,000 / $5,250,000 × $5,150,000 = $392,381

Credit Debit $5,150,000 242,381 Account Titles and Explanation Cash Discount on Bonds Payable Bonds Payable (24,000 $100) Common-Stock Warrants (to record issuance of bonds and warrants) $5,000,000 392,381

Credit $ Debit 392,381 2,500,000 Account Titles and Explanation Common-Stock Warrants Cash Common stock Additional paid in capital (to record exercise of warrants) $ 50,000 2,842,381

Answer-b:

The balance after the warrants are exercised on June 15 = $4,392,381 credit balance (1,500,000+50,000+2,842,381)