Question

On August 1, 2021, Limbaugh Communications issued $40 million of 8% nonconvertible bonds at 102. The bonds are due on July 31, 2041. Each $1,000 bond was issued with 20 detachable stock warrants, each of which entitled the bondholder to purchase, for $60, one share of Limbaugh Communications’ no par common stock. Interstate Containers purchased 20% of the bond issue. On August 1, 2021, the market value of the common stock was $58 per share and the market value of each warrant was $8.

In February 2032, when Limbaugh’s common stock had a market price of $71 per share and the unamortized discount balance was $1 million, Interstate Containers exercised the warrants it held.

Required:
1. Prepare the journal entries on August 1, 2021, to record (a) the issuance of the bonds by Limbaugh and (b) the investment by Interstate.
2. Prepare the journal entries for both Limbaugh and Interstate in February 2032, to record the exercise of the warrants.

Answer 1

Solution:

1)

Date	Account title and explanation	Debit	Credit
2021	Cash	$40,800,000
	Discount on bonds payable	$5,600,000
	Bond payable		$40,000,000
	Equity stock warranty		$6,400,000
	(To record the issuance of bond)
2021	Investment in stock warrants	$1,280,000
	Investment in bonds	$8,000,000
	Discount on bond investment		$1,120,000
	Cash paid		$8,160,000
	(To record the purchase of bond)

Working:

Limnaugh (issuer):

Cash Received = Face Value *Issued Rate

=$40,000,000*102%

=$40,800,000

Equity Stock Warrants = Market Price per warrant * Number of warrant * Number of Bonds

=$8*20*($40,000,000/$1,000)

=$6,400,000

Discount on Bonds Payable = Bond Payable + Equity Stock Warrant - Cash Received

=$40,000,000+$6,400,000-$40,800,000

=$5,600,000

Interstate (Investor):

Investment in stock warrants = Equity Stock Warrants * 20%

=$6,400,000*20%

=$1,280,000

Investment in bonds = Face Value * 20%

=$40,000,000*20%

=$8,000,000

Cash Paid = Face Value * Issued rate * 20%

=$40,000,000*102%*20%

=$8,160,000

Discount on Bond Investment = Investment in stock warrants + Investment in bonds - Cash Paid

=$1,280,000+$8,000,000-$8,160,000

=$1,120,000

2)

Event	Account title and explanation	Debit	Credit
1	Cash received	$9,600,000
	Equity stock warrant	$1,280,000
	Common stock		$10,880,000
	(To record the exercise of stock warrant)
2	Investment in common stock	$10,880,000
	Investment in stock warrants		$1,280,000
	cash paid		$9,600,000
	(To record the execrise of stock warrant)

Working:

Limbaugh (issuer):

Cash Received = Exercise Price per warrant * Number of warrants * Number of Bonds * 20%

=$60*20*($40,000,000/$1,000)*20%

=$9,600,000

Equity-stock warrants = Total Equity-stock warrants * 20%

=$6,400,000*20%

=$1,280,000

Common Stock = Cash Received - Equity-stock warrants

=$9,600,000+$1,280,000

=$10,880,000

Interstate (Investor):

Investment in stock warrants =Equity Stock Warrants * 20%

=$6,400,000*20%

=$1,280,000

Cash Paid = Exercise Price per warrant * Number of warrants * Number of Bonds * 20%

=$60*20*($40,000,000/$1,000)*20%

=$9,600,000

Investment in common Stock = Investment in stock warrants + Cash Paid

=$1,280,000+$9,600,000

=$10,880,000

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