Question

E16-7B (L02) (Issuance of Bonds with Warrants) MagTech Inc. requires funding to build a new factory and has decided to raise the additional capital by issuing $850,000 face value of bonds with a coupon rate of 10%. In discussions with investment bankers, it was determined that to help the sale of the bonds, detachable stock warrants should be issued at the rate of 5 warrants for each $1,000 bond sold. The value of the bonds without the warrants is considered to be $775,000, and the value of the war- rants in the market is $75,000. The bonds sold in the market at issuance for $825,000.

Instructions

(a) What entry should be made at the time of the issuance of the bonds and warrants?

       (b) If the warrants were nondetachable, would the entries be different? Discuss.

Answer 1

A)

Bank Ac Dr. $825,000

Discount on Bond payable Dr. $ 97,794  

Paid up capital-Stock warrants Cr. $72,794

10% Bonds Payable Cr $850,000

(Being 10% Bonds issued with detachable stock warrants , proceeds apportion between Equity and Debt as per the proportionate fair value)

Note:-  

When detachable stock warrants are issued the total proceeds need to be apportioned between Equity and debt based on the Fair value  

Total Value received = 825,000

Fair Value of Stock warrants = 75,000

Fair value of Bonds = 775,000

so Equity = 825,000*75000/850000= $72,794

For Bond = 825000*775000/ 850000= $752,206

Discount on Bond payable:-

Total bond face value = 850,000

Less: Allocated bond value = 752,206

Discount on Bond payable = $97,794

B) when the stock warrants are non detachable, it is not required to separately recognize the stock warrants. It is not possible to account separately as debt and equity elements can not be separated.

So the entry would be as follows:-

Bank Dr. $825,000

Discount on Bond payable Dr. $25,000

10%Bond Payable Cr $850,000

(Being 10% bonds issued with the Non detachable stock warrants)