Question - Lump-Sum Sale of Stock with Bonds
Zurg, Inc. is an SEC registrant, and its securities are thinly traded on NASDAQ (National Association of Securities Dealers Quotes). Zurg, Inc. issued 10,000 units. Each unit consists of a $1,000 par, 16% subordinated debenture and 5 shares of $5 par common stock. The investment banker has retained 500 units as the underwriting fee. The other 9,500 units were sold to outside investors for cash at $1,150 per unit. Prior to this sale the 2-week ask price of common stock was $25 per share. Sixteen per- cent is a reasonable market yield for the debentures, and therefore the par value of the bonds is equal to the fair value.
Instructions
(a) Prepare the journal entry to record the previous transaction, under the following conditions.
(1) Employing the incremental method.
(2) Employing the proportional method, assuming the recent price quotes on the common stock reflect fair value.
(b) Briefly explain which method is, in your opinion, the better method.