Question

Question: (Issuance of Bonds with Stock Warrants) On May 1, 2017, Friendly Company issued 2,000 \(1,000 bonds at 102. Each bond was issued with one detachable stock warrant. Shortly after issuance, the bonds were selling at 98, but the fair value of the warrants cannot be determined.

Instructions

(a) Prepare the entry to record the issuance of the bonds and warrants.

(b) Assume the same facts as part (a), except that the warrants had a fair value of \)30. Prepare the entry to record the issuance of the bonds and warrants.

Short answer

Answer

1. Cash is debited by $2,040,000; Discount on bonds payable is debited by $40,000 and Bonds payable is credited by $2,000,000; Paid-in capital- stock warrant is $80,000.
2. Cash is debited by $2,040,000; Discount on bonds payable is debited by $20,594 and Bonds payable is credited by $2,000,000; Paid-in capital- stock warrant is $60,594.

Step-by-step solution

(a) Journal entry to record issuance

Date	Accounts and Explanations	Debit	Credit
	Cash [(2,000*$1,000) *102%]	2,040,000
	Discount on bonds payable (2,000,000*2%)	40,000
	Bonds payable (2,000*$1,000)		2,000,000
	Paid-in capital- stock warrant ($2,040,000- $1,960,000)		80,000
	(Being recording insurance of the bond and warrant)

(b) Journal entry to record issuance with fair value of warrants

Date	Accounts and Explanations	Debit	Credit
	Cash [(2,000*$1,000) *102%]	2,040,000
	Discount on bonds payable (2,000,000- $1,979,406)	20,594
	Bonds payable		2,000,000
	Paid-in capital- stock warrant [($60,000/$2,020,000) *$2,040,000]		60,594
	(Being recording insurance of the bond and warrant)

Fair market value of bonds and stock warrant-

$$\begin{gathered} \mathbf{Fair}\mathbf{}\mathbf{value}\mathbf{}\mathbf{of}\mathbf{}\mathbf{bonds}\mathbf{=}\mathbf{Issued}\mathbf{}\mathbf{shares}\mathbf{\times }\mathbf{Sellingprice} \\ \mathbf{=}\mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{000}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{98}\mathbf{\%} \\ \mathbf{=}\mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{960}\mathbf{,}\mathbf{000} \\ \mathbf{Fair}\mathbf{}\mathbf{value}\mathbf{}\mathbf{of}\mathbf{}\mathbf{bonds}\mathbf{=}\mathbf{Issued}\mathbf{}\mathbf{no}\mathbf{}\mathbf{of}\mathbf{}\mathbf{shares}\mathbf{\times }\mathbf{Fair}\mathbf{}\mathbf{value} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{2}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{\$}\mathbf{30} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{\$}\mathbf{60}\mathbf{,}\mathbf{000} \end{gathered}$$

Allocation of cash received to bonds and warrants-

$$\begin{gathered} \mathbf{Allocated}\mathbf{}\mathbf{to}\mathbf{}\mathbf{bonds}\mathbf{=}\mathbf{Cash}\mathbf{\times }\frac{\mathbf{Fair}\mathbf{}\mathbf{value}\mathbf{}\mathbf{of}\mathbf{}\mathbf{bonds}}{\mathbf{Fair}\mathbf{}\mathbf{value}\mathbf{}\mathbf{of}\mathbf{}\mathbf{bonds}\mathbf{+}\mathbf{Fairvalue}\mathbf{}\mathbf{of}\mathbf{}\mathbf{stock}\mathbf{}\mathbf{warrant}} \\ \mathbf{=}\mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{040}\mathbf{,}\mathbf{000}\mathbf{\times }\frac{\mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{960}\mathbf{,}\mathbf{000}}{\mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{960}\mathbf{,}\mathbf{000}\mathbf{+}\mathbf{\$}\mathbf{60}\mathbf{,}\mathbf{000}} \\ \mathbf{=}\mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{979}\mathbf{,}\mathbf{406} \\ \mathbf{Allocated}\mathbf{}\mathbf{to}\mathbf{}\mathit{w}\mathit{a}\mathit{r}\mathit{r}\mathit{e}\mathit{n}\mathit{t}\mathbf{=}\mathbf{Cash}\mathbf{\times }\frac{\mathbf{Fair}\mathbf{}\mathbf{value}\mathbf{}\mathbf{of}\mathbf{}\mathbf{bonds}}{\mathbf{Fair}\mathbf{}\mathbf{value}\mathbf{}\mathbf{of}\mathbf{}\mathbf{bonds}\mathbf{+}\mathbf{Fairvalue}\mathbf{}\mathbf{of}\mathbf{}\mathbf{stock}\mathbf{}\mathbf{warrant}} \\ \mathbf{=}\mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{040}\mathbf{,}\mathbf{000}\mathbf{\times }\frac{\mathbf{\$}\mathbf{60}\mathbf{,}\mathbf{000}}{\mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{960}\mathbf{,}\mathbf{000}\mathbf{+}\mathbf{\$}\mathbf{60}\mathbf{,}\mathbf{000}} \\ \mathbf{=}\mathbf{\$}\mathbf{60}\mathbf{,}\mathbf{594} \end{gathered}$$