Holders of stock warrants have the option to purchase a specific number of shares of common stock at a predetermined price (exercise price) by the warrant’s expiration date. Stock warrants are typically attached to non-current liabilities, such as bonds, or equity, such as preferred stock. The equity account, "Additional Paid in Capital," is used when recording warrant transactions.
Fair Value of Stock Warrants
The majority of stock warrants are issued attached to preferred stock or bonds. The warrants have a fair value apart from the security to which they are attached. Calculation of the warrant's fair value is illustrated by the following example:
Corporation A issued a bond with 10 stock warrants attached. The market price of each warrant is $5. The fair value of the warrants equals $50 (one bond times 10 stock warrants times $5 market price). On the date of issuance, the warrant is recorded at fair value by crediting “APIC – Stock Warrants” along with other applicable accounts relating to the preferred stock or bond.
Exercise or Sale of a Stock Warrant
The decision to sell or exercise a stock warrant requires analysis. If a warrant’s expiration date is several years away, the warrant could be sold for well over its fair value if there are market expectations of the stock price rising over that period of time. If the exercise price is below the stock's market price, exercising the warrant right away allows the holder to acquire common stock and be eligible for the receipt of dividends on the common stock.
Journal Entry on Exercise Date
If the warrant holder decides to exercise the warrant, the “APIC – Stock Warrants” account is debited for the amount of warrants exercised and “Cash” is debited for the amount paid by the warrant holder. “Common Stock” is credited for the number of shares purchased multiplied by the stock’s par value (designated per share value) and “APIC – Common Stock” for the excess amount paid over the par value.
Presentation on the Balance Sheet
The presentation of the warrant before it is exercised is under the stockholder’s equity section in the account “APIC – Stock Warrants.” When the warrants are exercised and the journal entry recorded, the portion exercised is moved from “APIC – Stock Warrants” to stockholder’s equity accounts “Common Stock” and “APIC – Common Stock” for the value of the purchased shares at par and in excess of par.
- “Financial: CPA Exam Review”; DeVry/Becker Educational Development Corp.; 2009
- Investing Answers: Financial Dictionary: Warrants
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