On August 1, 2021, Limbaugh Communications issued $30 million of 10% nonconvertible bonds at 104. The bonds are due on July 31, 2041. Each $1,000 bond was issued with 20 detachable stock warrants, each of which entitled the bondholder to purchase, for $60, one share of Limbaugh Communications’ no par common stock. Interstate Containers purchased 20% of the bond issue. On August 1, 2021, the market value of the common stock was $58 per share and the market value of each warrant was $8. In February 2032, when Limbaugh’s common stock had a market price of $72 per share and the unamortized discount balance was $1 million, Interstate Containers exercised the warrants it held. Required: 1. Prepare the journal entries on August 1, 2021, to record (a) the issuance of the bonds by Limbaugh and (b) the investment by Interstate. 2. Prepare the journal entries for both Limbaugh and Interstate in February 2032, to record the exercise of the warrants.

Answers are journal entries, in the explanation box

Bonds is an interest bearing security or long term promissory note that a company represents while borrowing money with the interested investors.

The issuance of the bonds by Limbaugh (L)

Solution:

Following is the journal entry for the issuance of bonds on August 1, 2021:

1st August 2021:

Debit: Cash  $31,200,000 (Working 1)

Debit: Discount on bonds payable  $3,600,000 (Working 3: Note 1)

Credit: Bonds payable  $30,000,000

Credit: Equity - stock warrants $4,800,000 (Working 2)

Working 1:

Calculation of cash received:

Cash received = Face value × Issued rate

Cash received = $30,000,000 × 104%

Cash received = $31,200,000

Working 2:

Calculation of amount of equity - stock warrants:

Equity - stock warrants = Market price per warrant × number of warrants × number of bonds

Equity - stock warrants = $8 × 20 warrants × (30,000,000÷ 1,000 bonds)

Equity - stock warrants = $4,800,000

Working 3:

Calculate the discount on bonds payable:

Discount on bonds payable = Bonds payable + Equity stock warrants - Cash received

Discount on bonds payable = $30,000,000 + $4,800,000 - $31,200,000

Discount on bonds payable = $3,600,000

Note 1: Since discount on bonds issues is an expense, therefore, it is debited.

Prepare the journal entries on August 1, 2021, to record the investment by Interstate (I).

The following is the journal entry on August 1, 2021 to record the investment by Interstate (I) i.e. investor:

Debit: Investment in stock $960,000 (Working 4)

Debit: Investment in bonds $6,000,000 (Working 5)

Credit: Discount on bonds investment $720,000 (Working 7)

Credit: Cash $6,240,000 (Working 6)

Working 4:

Calculate the investment in stock warrants:

Investment in stock warrant = Equity - stock warrant × 20%

Investment in stock warrant = $4,800,000 × 20%

Investment in stock warrant  = $960,000

Working 5:

Calculate the amount of investment in bonds:

Investment in bonds = Face value × 20%

Investment in bonds = $30,000,000 × 20%

Investment in bonds = $6,000,000

Working 6:

Calculate the amount of cash paid:

Cash paid = Face value × issued rate × 20%

Cash paid = $30,000,000 × 104% × 20%

Cash paid = $6,240,000

Working 7:

Calculate discount on bond investment:

Discount on bond investment = Investment in stock warrants + Investment in bonds - Cash paid

Discount on bond investment = $960,000 + $6,000,000 - $6,240,000

Discount on bond investment = $720,000

Prepare the journal entries for Limbaugh in February 2032, to record the exercise of the warrants.

Solution:

Following is the journal entry for exercise of warrants by Limbaugh:

Debit: Cash: $7,200,000 (Working 8)

Debit: Equity - stock warrants $960,000 (Working 9)

Credit: Common stock - equity $8,160,000

Working 8:

Amount of cash received from the exercise:

Amount of cash received from the exercise = Exercise price per warrant × Number of warrants × Number of bonds × 20%

Amount of cash received from the exercise = $60 × 20 warrants × ($30,000,000/$1,000) × 20%

Amount of cash received from the exercise = $7,200,000

Working 9:

Amount of equity - stock warrants from exercise:

Equity - stock warrants = Total equity stock-warrants × 20%

Equity - stock warrants = $4,800,000 × 20%

Equity - stock warrants = $960,000

Working 10:

Amount of common stock:

Amount of common stock = Cash received + equity - stock warrants

Amount of common stock = $7,200,000 + $960,000

Amount of common stock = $8,160,000

Prepare the journal entries for Interstate in February 2032, to record the exercise of the warrants.

Solution:

The journal entry is as follows:

Debit: Investment in common stock: $8,160,000 (Working 13)

Credit: Investment in stock warrants: $960,000 (Working 11)

Credit: Cash: $7,200,000 (Working 12)

Working 11:

Amount of equity - stock warrants from exercise:

Equity - stock warrants = Total equity stock-warrants × 20%

Equity - stock warrants = $4,800,000 × 20%

Equity - stock warrants = $960,000

Working 12:

Calculate the amount of cash paid for exercise:

Amount of cash paid for the exercise = Exercise price per warrant × Number of warrants × Number of bonds × 20%

Amount of cash paid for the exercise = $60 × 20 warrants × ($30,000,000/$1,000) × 20%

Amount of cash paid for the exercise = $7,200,000

Working 13:

Investment in common stock:

Amount of common stock:

Investment in common stock = Cash paid + Investment in stock warrants

Investment in common stock = $7,200,000 + $960,000

Investment in common stock = $8,160,000