Hauser Corporation has $20,000,000 of outstanding debt that bears interest at a variable rate and matures on June 30, 2018. At inception of the debt, the company had a lower credit rating, and most available financing carried a variable rate. The company’s variable rate is the LIBOR rate plus 1%. However, the company’s credit rating has improved, and the company feels that a fixed, lower rate of interest would be most appropriate. Furthermore, the company is of the opinion that variable rates will increase over the next 24 months. In May 2016, the company negotiated with First Bank of Boston an interest rate swap that would allow the company to pay a fixed rate of 7% in exchange for receiving interest based on the LIBOR rate. The terms of the swap call for settlement at the end of June and December, which coincides with the company’s interest payment dates. The variable rates are reset at the end of each 6-month period for the following 6-month period. The terms of the swap are effective for the 6-month period beginning July 2016.The hedging relationship has been properly documented, and management has concluded that the hedge will be highly effective in offsetting changes in the cash flows due to changes in interest rates. The criteria for special accounting have been satisfied.   June 30, 2016 Dec. 31, 2016 June 30, 2017 Dec. 31, 2017 LIBOR rate Swap value 7.0%   7.1% $27,990 6.9% $(19,011) 6.8% $(19,342) 1. Prepare the necessary entries to record the activities related to the debt and the hedge from July 1, 2016, through June 30, 2018.2. Prepare a schedule to evaluate the positive or negative impact the hedge had on each 6- month period of earnings.3. What would the LIBOR rate on December 31, 2017, have had to be in order for the interest expense to be the same whether or not there was a cash flow hedge?

FINANCIAL ACCOUNTING
10th Edition
ISBN:9781259964947
Author:Libby
Publisher:Libby
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
icon
Related questions
icon
Concept explainers
Question

Hauser Corporation has $20,000,000 of outstanding debt that bears interest at a variable rate and matures on June 30, 2018. At inception of the debt, the company had a lower credit rating, and most available financing carried a variable rate. The company’s variable rate is the LIBOR rate plus 1%. However, the company’s credit rating has improved, and the company feels that a fixed, lower rate of interest would be most appropriate. Furthermore, the company is of the opinion that variable rates will increase over the next 24 months. In May 2016, the company negotiated with First Bank of Boston an interest rate swap that would allow the company to pay a fixed rate of 7% in exchange for receiving interest based on the LIBOR rate. The terms of the swap call for settlement at the end of June and December, which coincides with the company’s interest payment dates. The variable rates are reset at the end of each 6-month period for the following 6-month period. The terms of the swap are effective for the 6-month period beginning July 2016.
The hedging relationship has been properly documented, and management has concluded that the hedge will be highly effective in offsetting changes in the cash flows due to changes in interest rates. The criteria for special accounting have been satisfied.

  June 30, 2016 Dec. 31, 2016 June 30, 2017 Dec. 31, 2017

LIBOR rate

Swap value

7.0%

 

7.1%

$27,990

6.9%

$(19,011)

6.8%

$(19,342)

1. Prepare the necessary entries to record the activities related to the debt and the hedge from July 1, 2016, through June 30, 2018.
2. Prepare a schedule to evaluate the positive or negative impact the hedge had on each 6- month period of earnings.
3. What would the LIBOR rate on December 31, 2017, have had to be in order for the interest expense to be the same whether or not there was a cash flow hedge?

Expert Solution
steps

Step by step

Solved in 5 steps with 3 images

Blurred answer
Knowledge Booster
Cost of Capital
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, accounting and related others by exploring similar questions and additional content below.
Similar questions
Recommended textbooks for you
FINANCIAL ACCOUNTING
FINANCIAL ACCOUNTING
Accounting
ISBN:
9781259964947
Author:
Libby
Publisher:
MCG
Accounting
Accounting
Accounting
ISBN:
9781337272094
Author:
WARREN, Carl S., Reeve, James M., Duchac, Jonathan E.
Publisher:
Cengage Learning,
Accounting Information Systems
Accounting Information Systems
Accounting
ISBN:
9781337619202
Author:
Hall, James A.
Publisher:
Cengage Learning,
Horngren's Cost Accounting: A Managerial Emphasis…
Horngren's Cost Accounting: A Managerial Emphasis…
Accounting
ISBN:
9780134475585
Author:
Srikant M. Datar, Madhav V. Rajan
Publisher:
PEARSON
Intermediate Accounting
Intermediate Accounting
Accounting
ISBN:
9781259722660
Author:
J. David Spiceland, Mark W. Nelson, Wayne M Thomas
Publisher:
McGraw-Hill Education
Financial and Managerial Accounting
Financial and Managerial Accounting
Accounting
ISBN:
9781259726705
Author:
John J Wild, Ken W. Shaw, Barbara Chiappetta Fundamental Accounting Principles
Publisher:
McGraw-Hill Education