1.
Record the
1.
Explanation of Solution
Derivatives: Derivatives are some financial instruments which are meant for managing risk and safeguard the risk created by other financial instruments. These financial instruments derive the values from the future value of underlying security or index. Some examples of derivatives are forward contracts, interest rate swaps, futures, and options.
Interest rate swap: This is a type of derivative used by two parties under a contract to exchange the consequences (net cash difference between interest payments) of fixed interest rate for floating interest rate, or vice versa, without exchanging the principal or notional amounts.
Record the note payable as on January 1, 2016.
Date | Account titles and explanation | Debit ($) | Credit($) |
January 1, 2016 | Cash | $5,000,000 | |
Notes Payable | $5,000,000 | ||
(To record the note payable to bank) |
Table (1)
Record the interest payment on loan on December 31, 2016.
Date | Account titles and explanation | Debit ($) | Credit($) |
December 31, 2016 | Interest expenses | $450,000 | |
Cash | $450,000 | ||
(To record the payment of interest on $5 million bank loan) |
Table (2)
Working note (1):
Calculate the amount of interest paid on loan.
Record the interest rate swap receipt (payment) on December 31, 2016.
Date | Account titles and explanation | Debit ($) | Credit($) |
December 31, 2016 | Cash | $20,000 | |
Interest expenses | $20,000 | ||
(To record the interest rate swap receipt) |
Table (3)
Record the fair values and gains and losses on December 31, 2016.
Date | Account titles and explanation | Debit ($) | Credit($) |
December 31, 2016 | Loss in fair value of derivative (2) | $124,342 | |
Liability from interest rate swap | $124,342 | ||
(To record the loss on derivative swap) |
Table (4)
Working note (2):
Calculate the amount of present value:
Note: Factor of present value of ordinary annuity of $1: n = 3, i =10% is taken from the table value (Table 4 at the end of the time value money module).
Date | Account titles and explanation | Debit ($) | Credit($) |
December 31, 2016 | Note payable | $124,342 | |
Gain in value of debt (6) | $124,342 | ||
(To record the decrease in the value of note payable) |
Table (5)
Working note (3):
Calculate the amount of present value of principal.
Note:
Factor of present value of $1: n = 2, i =8% is taken from the table value (Table 3 at the end of the time value money module).
Working note (4):
Calculate the amount of present value of interest.
Note:
Factor of present value of ordinary annuity of $1: n = 3, i =10% is taken from the table value (Table 4 at the end of the time value money module).
Working note (5):
Calculate the amount of total present value.
Working note (6):
Calculate the decrease in the value of debt.
Record the interest payment on loan on December 31, 2017.
Date | Account titles and explanation | Debit ($) | Credit($) |
December 31, 2017 | Interest expenses (7) | $450,000 | |
Cash | $450,000 | ||
(To record the payment of interest on $5 million bank loan) |
Table (6)
Working note (7):
Calculate the amount of interest paid on loan.
Record the interest rate swap payment on December 31, 2017.
Date | Account titles and explanation | Debit ($) | Credit($) |
December 31, 2017 | Interest expenses | $25,000 | |
Cash | $25,000 | ||
(To record the interest rate swap payment) |
Table (7)
Record the fair values and gains and losses on December 31, 2017.
Date | Account titles and explanation | Debit ($) | Credit($) |
December 31, 2017 | Liability from interest rate swap | $124,342 | |
Asset from interest-rate swap (8) | $89,164 | ||
Gain in value of derivatives | $213,506 | ||
(To record the gain on derivative swap) |
Table (8)
Working note (8):
Calculate the present value.
Note: Factor of present value of ordinary annuity of $1: n = 2, i =8% is taken from the table value (Table 4 at the end of the time value money module).
Record the decrease in value of debt.
Date | Account titles and explanation | Debit ($) | Credit($) |
December 31, 2017 | Loss in value of debt | $213,506 | |
Note payable | $213,506 | ||
(To record the increase in the value of note payable) |
Table (9)
Working note (9):
Calculate the amount of present value of principal.
Note:
Factor of present value of $1: n = 2, i =8% is taken from the table value (Table 3 at the end of the time value money module).
Working note (10):
Calculate the amount of present value of interest.
Note:
Factor of present value of ordinary annuity of $1: n = 2, i =8% is taken from the table value (Table 4 at the end of the time value money module).
Working note (11):
Calculate the amount of total present value.
Working note (12):
Calculate the decrease in the value of debt.
2.
Prepare the appropriate disclosures in Company D’s financial statements for 2016 and 2017.
2.
Explanation of Solution
Financial statements: Financial statements are condensed summary of transactions communicated in the form of reports for the purpose of decision making.
Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.
Prepare the appropriate disclosures in Company D’s financial statements for 2016.
Income statement:
Company D | |
Income statement | |
For The Year Ending December 31, 2016 | |
Particulars | Amount |
Other items: | |
Interest expense (13) | ($430,000) |
Loss in value of derivative | ($124,342) |
Gain in value of debt | $124,342 |
Table (10)
Balance sheet:
Company D | |
Balance sheet | |
As at December 31, 2016 | |
Liabilities | Amount |
Long term liabilities: | |
Notes payable (14) | $4,875,658 |
Liability from interest-rate swap | $124,342 |
Table (11)
Working note (13):
Calculate the amount of interest expense to be reported in Income statement, 2016.
Working note (14):
Calculate the amount of note payable as on December 31, 2016.
Prepare the appropriate disclosures in Company D’s financial statements for 2017.
Income statement:
Company D | |
Income statement | |
For The Year Ending December 31, 2017 | |
Particulars | Amount |
Other items: | |
Interest expense (15) | ($475,000) |
Gain in value of derivative | $213,506 |
Loss in value of debt | ($213,506) |
Table (12)
Balance sheet:
Company D | |
Balance sheet | |
As at December 31, 2017 | |
Assets | Amount |
Long term assets: | |
Asset from interest-rate swap | $89,164 |
Liabilities | Amount |
Long term liabilities: | |
Note payable (16) | $5,089,164 |
Table (13)
Working note (15):
Calculate the amount of interest expense to be reported in Income statement, 2017.
Working note (16):
Calculate the amount of note payable as on December 31, 2017.
Want to see more full solutions like this?
Chapter 13 Solutions
EBK INTERMEDIATE ACCOUNTING: REPORTING
- Netflix company has entered into a plain vanilla interest rate swap on $2,500,000 notional principal. The company pays fixed rate of 7.0% on payments that occur at 60-day intervals. Six payments remain with the next one due in exactly 60 days. On the other side of the swap, the company receives payments based on the LIBOR rate. Describe the transaction that occurs between the company and the dealer at the end of the first period if the appropriate LIBOR rate is 8.5%.arrow_forwardOn January 2, 2020, MacCloud Co. issued a 4-year, $100,000 note at 6% fixed interest, interest payable semiannually. MacCloud now wants to change the note to a variable-rate note. As a result, on January 2, 2020, MacCloud Co. enters into an interest rate swap where it agrees to receive 6% fixed and pay LIBOR of 5.7% for the first 6 months on $100,000. At each 6-month period, the variable rate will be reset. The variable rate is reset to 6.7% on June 30, 2020. Instructions a. Compute the net interest expense to be reported for this note and related swap transaction as of June 30, 2020. b. Compute the net interest expense to be reported for this note and related swap transaction as of December 31, 2020.arrow_forwardOn January 2, 2020, Parton Company issues a 5-year, $10,000,000 note at LIBOR, with interest paid annually. The variable rate is reset at the end of each year. The LIBOR rate for the first year is 5.8%. Parton Company decides it prefers fixed-rate financing and wants to lock in a rate of 6%. As a result, Parton enters into an interest rate swap to pay 6% fixed and receive LIBOR based on $10 million. The variable rate is reset to 6.6% on January 2, 2021. Instructions a. Compute the net interest expense to be reported for this note and related swap transactions as of December 31, 2020. b. Compute the net interest expense to be reported for this note and related swap transactions as of December 31, 2021.arrow_forward
- On January 1, 2024, LLB Industries borrowed $228,000 from Trust Bank by issuing a two-year, 10% note, with interest payable quarterly. • LLB entered into a two-year interest rate swap agreement on January 1, 2024, and designated the swap as a fair value hedge. Its intent was to hedge the risk that general interest rates will decline, causing the fair value of its debt to increase. • The agreement called for the company to receive payment based on a 10% fixed interest rate on a notional amount of $228,000 and to pay interest based on a floating interest rate. The contract called for cash settlement of the net interest amount quarterly and rates reset at the beginning of each period. • Floating (SOFR) settlement rates were 10% at January 1, 8% at March 31, and 6% at June 30 and September 30, 2024. The fair values of the swap are quotes obtained from a derivatives dealer. Those quotes and the fair values of the note are as indicated below. Assume LLB uses the shortcut method. Fair value…arrow_forwardOn January 1, 2024, LLB Industries borrowed $212,000 from Trust Bank by Issuing a two-year, 10% note, with interest payable quarterly . LLB entered into a two-year interest rate swap agreement on January 1, 2024, and designated the swap as a fair value hedge. Its Intent was to hedge the risk that general Interest rates will decline, causing the fair value of its debt to Increase. . The agreement called for the company to receive payment based on a 10% fixed Interest rate on a notional amount of $212,000 and to pay Interest based on a floating interest rate. The contract called for cash settlement of the net interest amount quarterly and rates reset at the beginning of each period. . Floating (SOFR) settlement rates were 10% at January 1, 8% at March 31, and 6% at June 30 and September 30, 2024. The fair values of the swap are quotes obtained from a derivatives dealer. Those quotes and the fair values of the note are as indicated below. Assume LLB uses the shortcut method. Fair value of…arrow_forwardOn January 1, 2024, Avalanche Corporation borrowed $132,000 from First Bank by issuing a two-year, 8% fixed-rate note with annual interest payments. The principal of the note is due on December 31, 2025. • Avalanche wanted to hedge against declines in general interest rates, so it also entered into a two-year SOFR-based interest rate swap agreement on January 1, 2024, and designates it as a fair value hedge. Because the swap is entered at market rates, the fair value of the swap is zero at inception. . The agreement called for the company to receive fixed interest at the current SOFR swap rate of 5% and pay floating interest tied to SOFR. This arrangement results in an effective variable rate on the note of SOFR + 3%. • The contract specifies that the floating rate resets each year on June 30 and December 31 for the net settlement that is due the following period. In other words, the net cash settlement is calculated using beginning-of-period rates. The SOFR rates on the swap reset…arrow_forward
- ABC Corporation will be acquiring a P3,000,000 face value loan three months from now. It entered into an IRG 3-6 to set the interest rate of the loan to 8%. It paid P20,000 for the IRG. With this contract, what is the maximum simple effective interest rate relating to loan?arrow_forwardOn January 1, 2016, LLB Industries borrowed $340,000 from Trust Bank by issuing a two-year, 10% note, with interest payable quarterly. LLB entered into a two-year interest rate swap agreement on January 1, 2016, and designated the swap as a fair value hedge. Its intent was to hedge the risk that general interest rates will decline, causing the fair value of its debt to increase. The agreement called for the company to receive payment based on a 10% fixed interest rate on a notional amount of $340,000 and to pay interest based on a floating interest rate. The contract called for cash settlement of the net interest amount quarterly. Floating (LIBOR) settlement rates were 10% at January 1, 8% at March 31, and 6% June 30, 2016. The fair values of the swap are quotes obtained from a derivatives dealer. Those quotes and the fair values of the note are as indicated below. Fair value of interest rate swap Fair value of note payable January 1 March 31 0 $ 7,872 $340,000 $347,872 Net cash…arrow_forwardRequired information On January 1, 2024, Avalanche Corporation borrowed $130,000 from First Bank by issuing a two-year, 8% fixed-rate note with annual interest payments. The principal of the note is due on December 31, 2025. Avalanche wanted to hedge against declines in general interest rates, so it also entered into a two-year SOFR-based interest rate swap agreement on January 1, 2024, and designates it as a fair value hedge. Because the swap is entered at market rates, the fair value of the swap is zero at inception. The agreement called for the company to receive fixed interest at the current SOFR swap rate of 5% and pay floating interest tied to SOFR. This arrangement results in an effective variable rate on the note of SOFR + 3%. The contract specifies that the floating rate resets each year on June 30 and December 31 for the net settlement that is due the following period. In other words, the net cash settlement is calculated using beginning-of-period rates. The SOFR rates on the…arrow_forward
- Required Information On January 1, 2024, Avalanche Corporation borrowed $102,000 from First Bank by issuing a two-year, 8% fixed-rate note with annual interest payments. The principal of the note is due on December 31, 2025. • Avalanche wanted to hedge against declines in general interest rates, so it also entered into a two-year SOFR-based interest rate swap agreement on January 1, 2024, and designates it as a fair value hedge. Because the swap is entered at market rates, the fair value of the swap is zero at inception. • The agreement called for the company to receive fixed interest at the current SOFR swap rate of 5% and pay floating interest tied to SOFR. This arrangement results in an effective variable rate on the note of SOFR + 3%. • The contract specifies that the floating rate resets each year on June 30 and December 31 for the net settlement that is due the following period. In other words, the net cash settlement is calculated using beginning-of-period rates. The SOFR rates…arrow_forward(Fair Value Hedge Interest Rate Swap) On December 31, 2017, Mercantile Corp. had a $10,000,000, 8% fixed-rate note outstanding, payable in 2 years. It decides to enter into a 2-year swap with Chicago First Bank to convert the fixed-rate debt to variable-rate debt. The terms of the swap indicate that Mercantile will receive interest at a fixed rate of 8% andwill pay a variable rate equal to the 6-month LIBOR rate, based on the $10,000,000 amount. The LIBOR rate on December 31, 2017, is 7%. The LIBOR rate will be reset every 6 months and will be used to determine the variable rate to be paid for the following 6-month period.Mercantile Corp. designates the swap as a fair value hedge. Assume that the hedging relationship meets all the conditions necessary for hedge accounting. The 6-month LIBOR rate and the swap and debt fair values are as follows. Date 6-Month LIBOR Rate Swap Fair Value Debt Fair Value December 31, 2017 7.0% — $10,000,000 June 30, 2018 7.5% (200,000) 9,800,000…arrow_forwardABC Company enters into an IRG arrangement with Ch-bank for a 9 months, P800,000 loan starting 3 months from now. The IRG rate is at 11% and the bank quotes a premium of P4,000. Compute for the effective interest rate if the actual interest rate 3 months from now is 8% . Show your solution.arrow_forward
- AccountingAccountingISBN:9781337272094Author:WARREN, Carl S., Reeve, James M., Duchac, Jonathan E.Publisher:Cengage Learning,Accounting Information SystemsAccountingISBN:9781337619202Author:Hall, James A.Publisher:Cengage Learning,
- Horngren's Cost Accounting: A Managerial Emphasis...AccountingISBN:9780134475585Author:Srikant M. Datar, Madhav V. RajanPublisher:PEARSONIntermediate AccountingAccountingISBN:9781259722660Author:J. David Spiceland, Mark W. Nelson, Wayne M ThomasPublisher:McGraw-Hill EducationFinancial and Managerial AccountingAccountingISBN:9781259726705Author:John J Wild, Ken W. Shaw, Barbara Chiappetta Fundamental Accounting PrinciplesPublisher:McGraw-Hill Education