Accounting Adjustments to a Balance Sheet for Issuing Warrants

Detachable warrants may be traded as separate securities.

Accounting for stock warrants can be complex. Warrants are certificates granting the holder the right to buy common shares at a certain price within a certain period. If the warrants are exercised they dilute the earnings per share of the common stock of a corporation similar to that of the conversion of convertible securities. Warrants differ from convertible securities in the respect that the holder has to pay a price to obtain the shares.

Warrants As A marketing Stragedy And Incentive

Companies use warrants as “sweeteners” when issuing different types of securities, additional common stock, or stock options, as an attachment to the security. Stock warrants are most often attached to bonds or preferred stock. In this capacity the warrant is colloquially known as an equity kicker and acts as a long-term option to buy a common stock at a fixed price. Corporations may also issue warrants to existing stockholders as part of the holders' pre-emptive right to purchase common stock when the company is planning to issue additional stock to raise money. The warrants give the existing stockholders first call. Companies issue warrants to executives and employees as stock options to incite a better work performance.

Accounting For Warrants

When a company issues stock warrants with other securities, they are issued as either detachable or non-detachable. Detachable warrants may be traded as separate securities. The Financial Accounting Standards Board dictates that detachable stock warrants must be accounted for separately. This accounting can be done in one of two ways: the proportional method or the incremental method. When the company can determine the fair market value of the security and the warrant, the two must be accounted for with the proportional method. The company must determine the value of the bonds without the warrants, and the value of the warrants. Once the value is determined, the amount is recorded for the bonds and what amount for the warrants can calculated.

Allocating The Proceeds

If a company issues 1,000 bonds with a face value of $1,000 each sold at 101 percent of par -- the selling price -- with one detachable stock warrant. Each warrant allows the holder to purchase 10 shares of $10 par common stock at $37 per share. On the market, the bonds sell at 98 percent of par and the warrants had a market value of $40 each. The proportional method uses the fair market values to calculate the allocation percentages. The fair market value of the bonds is $980,000 -- 1,000 bonds x $1,000 bond face value per bond x 0.98 market selling price -- and the fair market value of the warrants is $40,000 -- 1,000 warrants x $40 market selling price. The sale of the bonds with detachable stock warrants is recorded by a journal entry debiting cash for $1,010,000 (1,000 bonds x $1,000 bond face value x 101 percent of bond par), debiting discount on bonds payable $29,608 -- (1,000 x $1,000) – ($980,000/($980,000 + $40,000)) -- crediting bonds payable for $1 million ($1,000 bond face value x 1,000 bonds), and crediting paid-in capital - stock warrants for $39,608 -- ($40,000/($980,000 + $40,000)) x $1,010,000.

Exercising Warrants

If the warrants are exercised, the cash proceeds equal the numbers of warrants exercised multiplied by the number of shares per warrant, multiplied by the exercise price. The amount recorded on the books for the warrants exercised is the number of warrants being exercised divided by the number of warrants outstanding, multiplied by the result of the market value of the warrants divided by the total of the market values of the bonds and warrants. The amount recorded to common stock is the number of warrants being exercised multiplied by shares per warrant, multiplied by par value per common share. If 800 warrants were exercised, the journal entry would be a debit to cash for $296,000 (800 x 10 x $37); a debit to paid-in capital – stock warrants for $31,686 -- (800/1,000) x ($40,000/($980,000 + $40,000); a credit to common stock of $80,000 (800 x 10 x $10); and a credit to paid-in capital in excess of par of $247,686 -- ($296,000 + $31,686) - $80,000).

References

• “Intermediate Accounting.” Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield. 2007.
• “Business Law: The Ethical, Global, and E-commerce Environment (13th ed.),” Jane P. Mallor, A. James Barnes, Thomas Bowers, Arlen W. Langvardt, 2004.
• “Principles of Managerial Finance, Brief Fourth Edition,” Lawrence J. Gitman, 2006.

Resources

• “Debtor's Accounting for a Modification (or Exchange) of Convertible Debt Instruments,” Financial Accounting Standards Board (FASB) Emerging Issues Task Force (EITF) Issue No. 06-6, October, 2006.
• “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants,” Accounting Principles Board of the American Institute of Certified Public Accountants, March, 1969.