Intermediate Accounting · Debt Issuance
Why a bond sold above par is still recorded at a discount when it comes with detachable warrants.
When a bond is sold with detachable stock warrants, the accountant treats it as two separate securities sold together: a bond and a set of warrants. The total cash received must be split between the two, using their relative fair values.
The warrants are not free. The bondholder paid for them, in effect, by accepting a bond that is worth less than the face amount. That is the whole puzzle: the bond portion of the deal is recorded at a discount, even though the combined package sold for more than par.
| Item | Fair value | Share | Allocated amount |
|---|---|---|---|
| Bonds (face $4,000,000) | $4,000,000 | 95.2% | $3,840,000 |
| Warrants (200,000 × $1) | $200,000 | 4.8% | $200,000 |
| Total | $4,200,000 | 100% | $4,040,000 |
The $4,040,000 cash received is split by relative fair value. The warrants get $200,000 (their own fair value), and the bonds get the rest: $3,840,000.
The split of $4,040,000 cash
The $160,000 gap is the discount: the bonds carry at $3,840,000 against a $4,000,000 face. The warrants are credited to equity, not debt.
Your instinct is right that the package sold at a premium: $4,040,000 cash for $4,000,000 of face value. But the premium belongs to the warrants, not the bonds.
Think of the fair values. The bond on its own is worth exactly $4,000,000. The warrants on their own are worth $200,000. Together that is $4,200,000 of value, but the buyer only paid $4,040,000. The buyer got a bargain of $160,000 on the whole package.
When we allocate the cash by relative value, the bonds receive $3,840,000 for a $4,000,000 face amount. That is $160,000 below face, a discount. The warrants receive $200,000, which is exactly their fair value.
So the bond is recorded at a discount because the warrants absorbed the premium. The bondholder paid less than face for the bond itself; the extra value they received came in the form of the warrants.
| Account | Debit | Credit |
|---|---|---|
| Cash | $4,040,000 | |
| Discount on bonds payable | $160,000 | |
| Bonds payable | $4,000,000 | |
| Paid-in capital, stock warrants | $200,000 |
Long-term debt is the net carrying value of the bonds: $4,000,000 − $160,000 = $3,840,000. The warrants are equity, not debt, so they do not count toward long-term debt.
Answer
C. $3,840,000
The warrants' $200,000 fair value is carved out of the proceeds and credited to equity. The bonds are left with $3,840,000, and that is the increase in long-term debt.