Detachable warrant accounting
/What are Detachable Warrants?
A detachable warrant is a derivative associated with a debt security that gives its owner the right to purchase issuer shares at a fixed exercise price. This type of warrant can be detached from the debt security with which it was originally issued, and then sold by itself in a secondary market. This means that an investor can sell the warrants while retaining the related debt security, or do the reverse and sell the security while retaining the warrants.
How to Account for Detachable Warrants
When detachable warrants are issued, allocate the proceeds from the sale of a debt instrument with detachable warrants between the two items, based on their free-standing relative fair values on the issuance date. Allocate the portion of the proceeds assigned to the warrants to paid-in capital, and the remainder to the debt instrument.
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Example of Detachable Warrant Accounting
Hostetler Corporation issues $1 million of convertible debt that includes 200,000 detachable warrants. The fair value of the convertible debt without the warrants is $900,000 and the fair value of the detachable warrants is $300,000 without the debt. Based on their relative fair values, Hostetler assigns $750,000 to the debt (calculated as $900,000 ÷ ($900,000 + $300,000)) and $250,000 to the detachable warrants (calculated as $300,000 ÷ ($900,000 + $300,000)). The resulting journal entry is:
| Debit | Credit | |
| Cash | $1,000,000 | |
| Additional paid-in capital | $250,000 | |
| Debt | 750,000 |