Bohn Industries THE CASE Company Background Bohn Industries (Bohn) manufactures houses and supplies manufactured housing for residential and commercial customers. Bohn developed a prefabrication process when building their manufactured housing to allow for a one day construction once the foundation has been set. In 2008, Bohn experienced a 40% decrease in demand for their prefabricated houses due to the significant downturn in the housing industry (Bohn, 20XX ). Bohn went through an initial public offering in 2003 when demand for their manufactured housing was at its peak. Bohn raised $75 million in its IPO using the proceeds for acquisitions, working capital, and to withstand the initial general economic downturn starting in 2007. The ensuing years saw significant restructuring along with the sell-off of certain divisions within the company (Bohn, 20XX). These sell-offs provided much needed cash to withstand the 2007-10 economic downturn. During the 4th quarter of 2010, its Board of Directors determined that the Company again needed financing since it had all but exhausted the cash proceeds from the initial IPO and more recent restructuringneeding about $20,000,000 in order to successfully execute its 2011 and 2012 business plans. Financing Details On April 1, 2011, a private equity group, Dunlap and Company (Dunlap), agreed to loan the Company $20,000,000; a two-year loan at a 20% interest rate, payable semi-annually on April 1st and October 1st of each year, with no principal payments due until the end of the loan. The debt is also convertible into shares of Bohn common stock at $1.50 per share. Bohn incurred $1,500,000 in financing costs related to this transaction and the costs were paid to Dunlap. To entice the private equity group to enter into the agreement, Bohn issued a warrant to buy 4,000,000 shares of common stock at an exercise price of $0.00001. Bohns common stock had traded at $2.00 per share on April 1, 2011 and the fair value of the warrant was determined by the Company to be $8,000,000. The Companys total common shares outstanding on a fully diluted basis were 15,845,000 on April 1, 2011. The fair value of the warrant was determined to be $10,000,000 and $9,000,000 on June 30, 2011 and September 30, 2011, respectively. Since the debt is convertible at a price per share less than the current trading price, Bohn determined that a beneficial conversion feature exists and computed the fair market value to be $4,000,000 at April 1, 2011. The fair value of the beneficial conversion feature was determined to be $6,000,000 and $5,000,000 on June 30, 2011 and September 30, 2011, respectively. As part of this agreement, Dunlap required Bohn to include the following anti-dilution provision in the loan agreement: Clause 1. Adjustment upon Issuance of Common Stock. If Bohn at any time or from time to time issues any additional Common Stock (including without limitation an issuance of any options, warrants or similar rights to purchase Common Stock or securities convertible into or exchangeable for Common Stock), and such additional Common Stock causes more than 15,845,000 shares of Common Stock to be outstanding on a Fully-Diluted Basis, then, and thereafter successively upon each such issuance, the number of Warrant Shares that may be obtained by Holders upon exercise of their Warrants shall forthwith be increased to allow the Holders to receive the same percentage of the total Common Stock outstanding on a Fully-Diluted Basis after the issuance of such additional Common Stock as they would have been able to receive upon exercise of the Warrants immediately prior to the issuance of such additional Common Stock. Additionally, the conversion price on the common stock would also be adjusted down to account for any additionally issued shares. The excerpt from the loan agreement relating to this provision is as follows: Clause 2. Adjustments for Issuance of Additional Stock; Change in Stock Price. If Bohn at any time or from time to time issues any additional Common Stock (including without limitation an issuance of any options, warrants or similar rights to purchase Common Stock or securities convertible into or exchangeable for Common Stock), and such additional Common Stock results in more than 15,845,000 shares of Common Stock to be outstanding on a Fully-Diluted Basis, then, and thereafter successively upon each such issuance, the current conversion price shall forthwith be reduced to a price that will allow the Holders of the Notes to convert into the same percentage of the total Common Stock outstanding on a Fully-Diluted Basis after the issuance of such additional Common Stock as they were able to convert into immediately prior to the issuance of such additional Common Stock. On September 30, 2011, Bohn and Dunlap agreed to fix the conversion price of the debt to be at $1.25 per share. The fair value of the beneficial conversion feature, considering the new conversion price was $6,500,000. REQUIREMENTS (Hint for warrants: Examine firm websites or google for the subject warrant classification) 1. List and discuss authoritative US GAAP guidance for all transactions. 2. Provide the initial journal entry and supporting calculations that Bohn needs to record on April 1, 2011. 3. Provide the journal entry and supporting calculations that Bohn needs to record on June 30, 2011. 4. Provide the journal entry and supporting calculations that Bohn needs to record on September 30, 2011. 5. Being cash poor, assume Bohn chose to (and legally could) pay interest by issuing common stock rather than paying with cash. Discuss the implications of this decision. 6. What advice would you have given Bohn before the transaction was entered into that might have mitigated the impact on Bohns future earnings.