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Definition: Detachable Warrants
Detachable warrants are derivative securities that provides holders the right to purchase the underlying asset at a predetermined price, within a specified period and which can be sold separately from the securities to which they were initially attached. Warrants are commonly offered via direct sales, as employee initiatives or they can be attached to newly issued securities. Detachable warrants provide the option for investors to sell the attached warrants in the secondary markets while retaining the original securities. Detachable warrants as well as the debt offering should be treated as separate securities.
Companies benefit from detachable warrants at the time of issuing new offerings of bonds as they make the debt offerings attractive for investors and can serve as an effective method of raising capital. The holder of the detachable warrant can gain from exercising the warrants when the market price rises, by purchasing the underlying security at the lower predetermined price.
The issuer allocates the sales proceeds from a debt security and the associated detachable warrant in proportion to their fair-market values on the date of issuance. Thus, when detachable warrants are exercised, the issuer records a cash debit for the exercise price in the journal entry and the remaining proceeds are allocated to the paid-in capital account.
For example, suppose that a company issues convertible debt $1 million and the fair-value of the convertible debt in the absence of detachable warrants is $750,000 while that of the detachable warrants is $500,000. As such, the company would allocate $1 million * [$750,000/($750,000 + $500,000) ]= $600,000 to the debt and $400,000 to the additional paid-in capital account in its journal entry.