A Company issued a bond payable with detachable warrants on January 1, 20X1 as follows.

Bond payable ($1,000 par value; 400 bonds) $400,000
Coupon rate 4.70%
Bond issue price $414,000
Fair value of the bonds after issuance $390,000
Term 10 years
Number of detachable warrants per bond 50
Fair value of the warrants after issuance $2.00
Stock purchase price $15.00
Warrants exercised 5,000

Required:
1 warrant = 1 share of $1 par value stock
1) What is the interest expense in 20X1?
2) What is the credit to additional paid in capital at the time the warrants are exercised on June 30, 20X1?

1. The interest expense in 20X1 is $18,800

2. The credit to additional paid in capital at the time the warrants are exercised on June 30, 20X1 is $79,628

Explanation:

According to the given data we have the following:

Par Value of Bonds issued      =   $4,00,000

Coupon Rate                           =      4.70%

Therefore, Interest Expense for the year =   $400,000 * 4.70%

1. Interest Expense for the year = $18,800

2. a) Journal Entry when bonds(with detachable warrants) are issued - Market Value Method

Cash A/c   $414,000                        

Discount on Bonds payable A/c *  $24,512

                        To Bonds payable A/c $400,000

                         To APIC-warrants A/c **$38,512

$          38,512

* Balancing figure

** Fair value of the bonds = $ 390,000

  Fair Value of Warrants   = $ 40,000

   (400 bonds * 50 warrants * $2)

APIC-Warrants = Price of bonds * (FV of warrants)/(FV of warrants+FV of bonds)

                          = 414,000 * 40000/(40000+390,000)

                          = $ 38,512

b) Entry on exercise of 5000 warrants  $15

       Given 1 warrant = 1 share of $1 par value

       Therefore 5000 warrants                 = 5000 shares

       Total detachable Warrants issued    = 400 bonds * 50 each

= 20,000

Cash A/c (5000 shares * $15 )

$                   75,000  

APIC-warrants A/c ($38512 * 5000/20000)

$                     9,628  

To common stock A/c (5000 shares * $1)

$            5,000

To APIC A/c

$          79,628

2. Therefore,  Credit to Additional paid in capital account at the time of exercise of warrants = $ 79,628

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