On December 1, 2014, Lester Company issued at 103, five hundred of its 9%, $1,000 bonds. Attached to each bond was one detachable stock warrant entitling the holder to purchase 10 shares of Lester's common stock. On December 1, 2014, the market value of the bonds, without the stock warrants, was 95, and the market value of each stock purchase warrant was $50. The amount of the proceeds from the issuance that should be accounted for as the initial carrying value of the bonds payable would be

Question

Quizplus · Accepted Answer

The proceeds from the issuance of the bonds payable would include the amount received from selling the bonds and the market value of the stock purchase warrants attached to each bond.

The amount received from selling the bonds would be:

500 bonds x $1,000 face value x 103% = $515,000

The market value of the stock purchase warrants would be:

500 bonds x 10 warrants per bond x $50 per warrant = $250,000

Therefore, the total proceeds from the issuance would be:

$515,000 + $250,000 = $765,000

The initial carrying value of the bonds payable would be the present value of the future cash flows of the bond, which can be calculated using the market rate of interest. Since the market value of the bond without the warrants is 95, this implies that the market rate of interest is higher than the stated rate of 9%.

Assuming a market rate of 10%, the present value of the future cash flows of the bond would be:

PV = $90 x [(1 - 1/1.1^5)/0.1] + $1,000/1.1^5 = $786.57

Therefore, the initial carrying value of the bond payable would be:

$786.57 x 500 bonds = $393,285

Adding the value of the stock purchase warrants ($250,000) to the initial carrying value of the bonds payable ($393,285) gives:

$393,285 + $250,000 = $643,285

However, the bonds were issued at 103% of face value, which means that the total proceeds from the issuance were higher than the initial carrying value of the bonds payable calculated above. The difference between the two amounts represents a premium on the bonds, which is recorded as a liability on the balance sheet.

The total proceeds from the issuance were $765,000, which is $121,715 higher than the initial carrying value of the bonds payable ($643,285). Therefore, the premium on the bonds would be:

$765,000 - $643,285 = $121,715

The amount of the proceeds from the issuance that should be accounted for as the initial carrying value of the bonds payable would be:

$643,285 (initial carrying value of bonds payable) / 500 bonds = $1,286.57 per bond

Multiplying this amount by the number of bonds issued gives:

$1,286.57 x 500 bonds = $643,285

Therefore, the correct answer is choice B ($489,250 is not correct because it does not take into account the market value of the stock purchase warrants).

On December 1, 2014, Lester Company Issued at 103, Five