Question

On May 1, 2014, Marly Co. issued $1,500,000 of 7% bonds at 103, which are due on April 30, 2024. Twenty detachable stock warrants entitling the holder to purchase for $40 one share of Marly's common stock, $15 par value, were attached to each $1,000 bond. The bonds without the warrants would sell at 96. On May 1, 2014, the fair value of Marly's common stock was $35 per share and of the warrants was $2.

On May 1, 2014, Marly should record the bonds with a
a. discount of $60,000.
b. discount of $15,000.
c. discount of $16,800.
d. premium of $45,000.

Answer 1

Marly Co. should record the bonds with a premium of $45,000 on May 1, 2014, since the bonds sold at 103% versus their 96% value without the detachable stock warrants.

Step-by-step explanation:

On May 1, 2014, when Marly Co. issued $1,500,000 of 7% bonds at 103, a premium is being paid since the bonds were sold for more than their face value (103% of the face value). However, to determine the premium on the bonds, we have to consider the value of the detachable stock warrants that were included with the bonds. Without the warrants, the bonds would have been sold at 96, indicating that a part of the sale price relates to the warrants and not the bonds themselves.

To record the bonds at the appropriate premium or discount, the fair value of the bonds and the warrants must be established. In the scenario given, we were not provided with the exact fair value of the bonds without the warrants, but we can deduce that the premium is the difference between the sale price of 103% of the face value and the price at which the bonds would sell without the warrants, which is 96% of the face value. Therefore, Marly should record the bonds with a premium of $45,000 ((103 - 96) x ($1,500,000 / 100)).