Chapter 16: Stock Warrants

Question 1

How do we account for stock warrants when they are attached to other instruments?

Answer 1

We have two options:

Proportional Method

Incremental Method

Question 2

What is the proportional method?

Answer 2

Proportional Method: Take the relative fair values of the debt (or other instrument) and of the warrant. Allocate the purchase price of the security pro rata between the two instruments.

Question 3

What is the incremental method?

Answer 3

Incremental Method: Calculate the value of the debt (or other instrument) and then allocate any extra cost to the warrant.

Question 4

——— BACKGROUND———-
On October 1, 2021, Pumpkin Corporation issued $600,000 of 8% semi-annual bonds at 104. Each $1,000 bond carried 50 warrants.

The exchange of a warrant allowed the holder
to one share of $1 par value common stock for $60.

Around the time of the issue, the bonds were quoted at 99 ex rights and the warrants were quoted at $6.

——— QUESTION———-

What did investors pay for the bond with the warrants?

Answer 4

104 means the price paid was 600,000 x 104% = $624,000

Question 5

——— BACKGROUND———-
On October 1, 2021, Pumpkin Corporation issued $600,000 of 8% semi-annual bonds at 104. Each $1,000 bond carried 50 warrants.

The exchange of a warrant allowed the holder
to one share of $1 par value common stock for $60.

Around the time of the issue, the bonds were quoted at 99 ex rights and the warrants were quoted at $6.

——— QUESTION———-

How many warrants are outstanding?

Answer 5

50 warrants per thousand, 600 thousand

= 30,000 warrants

Question 6

——— BACKGROUND———-
On October 1, 2021, Pumpkin Corporation issued $600,000 of 8% semi-annual bonds at 104. Each $1,000 bond carried 50 warrants.

The exchange of a warrant allowed the holder
to one share of $1 par value common stock for $60.

Around the time of the issue, the bonds were quoted at 99 ex rights and the warrants were quoted at $6.

——— QUESTION———-

For proportional method: what is the fair value of the underlying securities, detached:

Answer 6

• Bond: 600 x .99 = 594,000
• Warrants: 30,000 x 6 = 180,000
• Total fair value of underlying securities: 774,000
• Of the total fair value: 23% warrants and 77% bond
• Allocate the purchase price according to these percentages:
  o .23 x 624,000 = 143,520 for warrants
  o .77 x 624,000 = 480,480 for bond

Question 7

——— BACKGROUND———-
On October 1, 2021, Pumpkin Corporation issued $600,000 of 8% semi-annual bonds at 104. Each $1,000 bond carried 50 warrants.

The exchange of a warrant allowed the holder
to one share of $1 par value common stock for $60.

Around the time of the issue, the bonds were quoted at 99 ex rights and the warrants were quoted at $6.

——— QUESTION———-
If the warrants are worth $143,520 and the bonds are worth $480,480 - what does the journal entry look like?

Answer 7

Bond:
Dr. Cash 480,480
Dr. Discount on Bonds Payable 119,520
Cr. Bonds Payable 600,000

Warrants:
Dr. Cash 142,520
Cr. APIC – Warrants 142,520

Question 8

——— BACKGROUND———-
On October 1, 2021, Pumpkin Corporation issued $600,000 of 8% semi-annual bonds at 104. Each $1,000 bond carried 50 warrants.

The exchange of a warrant allowed the holder
to one share of $1 par value common stock for $60.

Around the time of the issue, the bonds were quoted at 99 ex rights and the warrants were quoted at $6.

——— QUESTION———-
What does the journal entry for an exercise of the warrants look like?

Answer 8

Dr. Cash 1,800,000 (=30,000 warrants x $60)
Dr. APIC – Warrants 142,520
Cr. Common Stock, at par 30,000
Cr. APIC – CS 1,912,520