During 2014, Gordon Company issued at 104 four hundred, $1,000 bonds due in ten years. One detachable stock warrant entitling the holder to purchase 15 shares of Gordon's common stock was attached to each bond. At the date of issuance, the market value of the bonds, without the stock warrants, was quoted at 96. The market value of each detachable warrant was quoted at $40. What amount, if any, of the proceeds from the issuance should be accounted for as part of Gordon's stockholders' equity?

Question

Quizplus · Accepted Answer

The total amount received from the issuance of the bonds can be calculated as follows:

$1,000 × 400 × 104% = $416,000

The market value of the bonds without the stock warrants is quoted at 96%, which implies that the fair value of the bonds is $960 per bond. Therefore, the total value of the bonds without the stock warrants is:

$960 × 400 = $384,000

Hence, the fair value of the warrants can be calculated as:

$40 × 400 = $16,000

As each warrant allows the holder to purchase 15 shares, the number of shares that can be issued is:

400 × 15 = 6,000

The market price of Gordon's common stock at the issuance date is not given, so we cannot determine the fair value of the shares that could potentially be issued upon exercise of the warrants. However, we do know that the proceeds from the issuance of the bonds should be allocated between the liability component (i.e., the bonds without the warrants) and the equity component (i.e., the warrants).

We can use the relative fair value method to determine this allocation. The fair value of the bonds without the warrants is $384,000, which represents 92.31% of the total proceeds ($384,000 ÷ $416,000). Therefore, the equity component is:

$416,000 × 7.69% = $32,000

Since each warrant is worth $40, the number of warrants included in the issuance is:

$32,000 ÷ $40 = 800

However, only 400 bonds were issued, so the number of warrants that can be assigned to these bonds is limited to 400 × 1 = 400. Hence, the remaining warrants (i.e., 800 - 400 = 400) must be recorded as additional paid-in capital.

The amount to be accounted for as part of Gordon's stockholders' equity is therefore:

$16,000 (fair value of the warrants assigned to the bonds) + $16,640 (fair value of the remaining warrants assigned to additional paid-in capital) = $32,640

This amount is more than option B and less than option D, so the answer is C.

During 2014, Gordon Company Issued at 104 Four Hundred, $1,000