Basics of stock warrant accounting
March 1, 2015
In this article, we’ll briefly describe how to account for stock warrants, which can be detached from a bond and exchanged for common stock – almost like a coupon
When issuing bonds, a company has a lot of flexibility when deciding how to make the bonds more desirable on the market. The stated interest rate can be adjusted, a conversion feature could be added – anything that makes the bond more attractive to potential investors. One such option is the addition of stock warrants to the bond. A stock warrant is a small document that can be separated from the bond itself and separately traded or used. It acts like a stock option, giving the holder the right to purchase common stock for a specified price.
In our previous discussion about convertible bonds, we mentioned that, under U.S. GAAP, the conversion feature is not separately recorded in equity – the entire issuance price is recorded as a bond liability. Stock warrants, on the other hand, are accounted for a bit differently.
When a bond with warrants is issued, the price paid must be allocated based on the fair value of the warrants and the fair value of the bond. The amount allocated to the warrants is recorded in an additional paid-in capital account specifically reserved for stock warrants, while the remainder is recorded as a bond liability.
There are two possible ways to allocate the issuance price between the warrants and the bond. Sometimes, only the warrants have a known fair value. If this is the case, that amount is allocated to the warrants, and the rest of the price is allocated to the bond. Other times, the fair value of the bond is also known, in which case the amounts recorded are based on the proportion of the known values. For example, if the fair value of the warrants is $100 and the fair value of the bond is $900, 10% of the issuance price would be assigned to the warrants and 90% would be allocated to the bond.
When a warrant holder redeems the instrument, the holder receives stock in exchange for the warrant and the specified cash price. At redemption, the company records a debit to cash and the warrant’s additional paid-in capital. At the same time, it records a credit to common stock for the par value of the stock issued and a credit to additional paid-in capital (common stock) for an amount that balances the entry.
Generally, warrants are only redeemable for a specified period of time. If the warrants are not used before the expiration date, the balance in the additional paid-in capital account set aside for the warrants is shifted to the additional paid-in capital account related to common stock.
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