During 2020, Khartoum Corp. issued four hundred $ 1,000 bonds at 104. One detachable warrant, entitling the holder to purchase 15 of Khartoum' common shares, was attached to each bond. At the date of issuance, the market value of the bonds, without the warrants, was 96. The market value of each warrant was $ 40. Using the relative fair value method, what amount should Khartoum credit to Bonds Payable from the proceeds?
A) $ 416,000
B) $ 400,000
C) $ 399,360
D) $ 384,000

Question

Quizplus · Accepted Answer

To determine the allocation of proceeds between the bond liability and the detachable warrants, we need to use the relative fair value method.

Step 1: Calculate the total proceeds from issuing the four hundred $1,000 bonds at 104. 
400 bonds x $1,000/bond x 104% = $416,000

Step 2: Calculate the total fair value of the bonds without the warrants: 
400 bonds x $1,000/bond x 96% = $384,000

Step 3: Calculate the total fair value of the warrants: 
400 bonds x 15 warrants/bond x $40/warrant = $240,000

Step 4: Allocate the total proceeds between the bond liability and the detachable warrants based on their relative fair values: 
Bond liability: $384,000 / ($384,000 + $240,000) x $416,000 = $399,360 
Detachble warrants: $240,000 / ($384,000 + $240,000) x $416,000 = $16,640

Therefore, the amount Khartoum should credit to Bonds Payable from the proceeds is $399,360.