Question

On July 4, 2014, Chen Company issued for $8,400,000 a total of 80,000 shares of $100 par value, 7% noncumulative preferred stock along with one detachable warrant for each share issued. Each warrant contains a right to purchase one share of Chen $10 par value common stock for $15 per share. The stock without the warrants would normally sell for $8,200,000. The market price of the rights on July 1, 2014, was $2.50 per right. On October 31, 2014, when the market price of the common stock was $19 per share and the market value of the rights was $3.00 per right, 32,000 rights were exercised. As a result of the exercise of the 32,000 rights and the issuance of the related common stock, what journal entry would Chen make?

A. Cash........................................................................................ 480,000
Common Stock ............................................................ 320,000
Paid-in Capital in Excess of Par ..................................... 160,000
B. Cash........................................................................................ 480,000
Paid-in Capital—Stock Warrants ............................................... 80,000
Common Stock ............................................................ 320,000
Paid-in Capital in Excess of Par ..................................... 240,000
C. Cash........................................................................................ 480,000
Paid-in Capital—Stock Warrants ............................................... 200,000
Common Stock ............................................................ 320,000
Paid-in Capital in Excess of Par ..................................... 360,000
D. Cash........................................................................................ 480,000
Paid-in Capital—Stock Warrants ............................................... 120,000
Common Stock ............................................................ 320,000
Paid-in Capital in Excess of Par ..................................... 280,000

Answer 1

The exercise of the 32,000 rights at $15 per share amounts to cash received of $480,000. The journal entry would include a debit to cash and corresponding credits to common stock (at the par value of $10 per share) and to paid-in capital in excess of par for the amount above the par value.

Step-by-step explanation:

When the 32,000 rights to purchase Chen Company's common stock were exercised, investors paid $15 for each share of common stock. To record this transaction, we first multiply 32,000 rights by $15, the exercise price per share, to find out the total cash received which is $480,000. The number of shares issued is again 32,000 (as one right corresponds to one share), and since the common stock has a par value of $10, the entry for common stock at par value is $320,000 (32,000 shares × $10).

The paid-in capital or additional paid-in capital represents the amount received over and above the par value from the issuance of shares. For each share, this is $5 ($15 received - $10 par value). So for 32,000 shares, this becomes $160,000 (32,000 shares × $5).

However, there is no information provided about how the detachable warrants were initially valued when the preferred stock and warrants were issued. It is not appropriate to create an entry for Paid-in Capital—Stock Warrants without that information. Therefore, the simplest entry for this transaction, without further information on the initial valuation of the warrants, is to debit Cash and credit Common Stock and Paid-in Capital in Excess of Par.

The correct journal entry to reflect the exercise of the rights is Option A:

Cash ........................................................................................ 480,000
Common Stock ............................................................ 320,000
Paid-in Capital in Excess of Par ..................................... 160,000