Question

On May 1, 2010, Payne Co. issued $300,000 of 7% bonds at 103, which are due on April 30, 2020. Twenty detachable stock warrants entitling the holder to purchase for $40 one share of Payne'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, 2010, the fair value of Payne's common stock was $35 per share and of the warrants was $2.

On May 1, 2010, Payne should credit Paid-in Capital from Stock Warrants for
a. $11,520.
b. $12,000.
c. $12,360.
d. $21,000.

Answer 1

Using the incremental method, the difference in proceeds between the bonds with warrants issued at a premium and the value of the bonds without warrants is allocated to the warrants, which amounts to $21,000.

Step-by-step explanation:

The question is asking to determine the allocation of the bond proceeds between the bonds themselves and the detachable stock warrants.

To calculate this, one would typically use either the proportional method or the incremental method. Unfortunately, not enough information is provided to use the proportional method since the total fair value of the bonds and warrants combined are not given. Thus, we would use the incremental method, where the value of the bonds without the warrants is known ($300,000 x 96% = $288,000), and the remainder of the proceeds would then be allocated to the warrants. Considering the bonds were issued at 103, which means at a premium ($300,000 x 103% = $309,000), the difference ($309,000 - $288,000 = $21,000) would be allocated to the warrants. This process involves recognizing the intrinsic value of both the bonds and the attached warrants separately on the date of issuance.