Question

On January 1, 20X1, Metro Plaza Inc. (MPI), a real estate company, using IFRS, issued $1,000,000, 8%, five year bonds for a cash price of $1,250,000. Interest is payable semi-annually on June 30 and December 31. Each $100 bond includes 20 warrants. Each warrant can be exchanged for one common share of MPI at an exercise price of $10 per share. The market rate of interest is 6% for similar bonds without warrants and the fair market value of these bonds was determined to be $1,085,302.

Required:

1. Prepare the appropriate journal entry to record the issue of the bonds on January 1, 20X1;
2. Prepare the appropriate journal entry required on December 31, 20X1;
3. How would the bonds be reported on the balance sheet at December 31, 20X1;
4. 30% of the warrants were exercised on July 1, 20X3 when the shares of MPI were being traded at $11,50. Prepare the appropriate journal entry or entries which the company should make on July 1, 20X3 to record this transaction.

Note: You may find it useful to answer this question by preparing a bond amortization table.

Answer 1

Answer:-

The entry to record the issuance of the bonds with warrants is as follows:

The share warrants is assigned a residual value, meaning any excess of the issuance price over the fair value of the bonds without the warrants is fair value of the warrants. The fair value of the bonds without warrants is 1,085,302 (the bonds is issued at a premium of 85,302). The share warrants are then assigned a value of 164,698 (1,250,000 - 1,085,302).

The only entry to be made regarding the bonds on Dec 31, 20x1 is the recording of interest and premium amortization. Interest expense is computed as (carrying value of bonds x semi-annual effective interest rate). The amortization of the bond premium is equal to the difference of interest paid and interest expense recognized. The complete amortization of the bonds is provided below.

On Dec 31, 20x1, the bonds will be presented in the balance sheet under the non-current liabilities section. The bonds will be valued at 1,070,197. On the other hand, the share warrants outstanding account will be presented as part of the additional paid-in capital. It should be noted that the "share warrants outstanding" account is an equity account and not a liability account.

Before recording the exercise of the warrants, it is necessary to compute first how many shares were issued as a result of the transaction. As per stated in the problem, each $100 bond has 20 warrants and each warrant can be exercised to acquire 1 common share of MPI. 30% of the warrants were exercised and 60,000 common shares were issued. Since there is no given data about the par value of the common shares of MPI, it is to be assumed that the exercise price of $10 is the stated price/par value of the common shares. As such, the total exercise price of 600,000 is recorded as part of ordinary shares, and the share warrants outstanding is derecognized and included as part of share premium. The market value of the shares is irrelevant in the exercise of the warrants.