Question

Adjusting entry: The company recognizes accrued interest for the bonds issued on August 1st. The company uses straight line method for the bond issued on August 1st. The fair value of the shares is $5,200,000.

The August 1st transaction was: Issued $3 million of 10% nonconvertible bonds at 104. 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 no par common stock. The market value of the common stock was $58 per share and the market value of the stock warrant was $8.

What is the adjusting entry?

Answer 1

Detachable Warrant can be separated from the security (Bond) and traded as a separate security. So we have to determine/allocate the amount collected on sale of Bonds between bond and warranty.
To allocate the value betweeen Bond and warranty we use Proportionate method using Fair value
Calculations:
01. Computation of Number of Bonds issued
Amount collected by selling bond	3,000,000
Par value of Bond	1,000
No of bonds issued = 3,000,000/1000	3,000
02.Number of detachable stock warrants
20 warrants per bond. (3000 Bonds * 20 detachable stock warrants)	60,000
03.Fair Value of Bond
Market Value of Bond	58
Market Value of Warran	8
Total Fair value= (58+8)	66
04.Proportionate Method
Proportionate of Bond= 58/66	87.88
Proportionate of Warrant= 8/66	12.12
	100.00
05.Allocation of total sale vale of Bonds
Allocation to Bonds = 3000000* 87.88%	2,636,400
Allocation to Warrant = 3000000* 12.12%	363,600
Total Sale value	3,000,000
06.Computation of discount on bond
Par value of Bond issued= 3000 Bonds @ $.1,000	3,000,000
Allocation to Bond	2,636,400
Dicount on issue of Bond	363,600

Journal Entries
1	For recording sale of 3000 Bonds @ 104% with 20 stock warrants for each Bond
	Particulars	Dr/Cr	Debit($)	Credit($)
	Cash/Bank Ac	Dr.	3,120,000
	Bond Discount A/c	Dr.	243,600
	To, Bonds payable	Cr.		3,000,000
	To, Stock Warrant A/c	Cr.		363,600
	( 3000 bonds issued @ 104% of par value. i.e $ 1040 with 20 detachable stock warrant for wach bond)
2	For recording Interest expenses for 1st year
	Interest Expenses Ac	Dr.	300,000
	To, Interest Payable Ac	Cr.		300,000
	( 1st August to July 31st. 12 months @ 10% p.a on Bond Value 3,000,000)
3	On maturity i.e due date 31st July 2041
	Bond Payable Ac	Dr.	3,000,000
	Interest Payable Ac	Dr.	300,000
	To Cash/Bank Ac	Cr.		3,300,000
	(Bond amount is paid along with current year Interest)