(Appendix 13.1) Derivatives Anglar Company has a $3 million, 7% bank loan from Castle Rock Bank. On January 1, 2019, when the $3 million loan has 3 years remaining, Anglar contracts with Susan Investment Bank to enter into a 3-year interest rate swap with a $3 million notional amount. Anglar agrees to receive from Susan a fixed interest rate of 7% and to pay Susan an interest amount each year that is variable based on the LIBOR interest rate at the beginning of the year. The interest payments are made at year-end. The applicable interest rate on the swap is reset each year after the annual interest payment is made. The LIBOR interest rate is 6.6% at the beginning of 2019. The 3-year fixed interest rate is 8% at December 31, 2019.
Required:
- 1. Prepare the
journal entries of Anglar for the bank loan and derivative for 2019. Round answers to the nearest dollar. - 2. Prepare the appropriate disclosures in Anglar’s financial statements for 2019.
1.
Prepare the journal entries in the books of Company A for the bank loan and derivative for 2019.
Explanation of Solution
Derivatives: Derivatives are some financial instruments which are meant for managing risk and safeguard the risk created by other financial instruments. These financial instruments derive the values from the future value of underlying security or index. Some examples of derivatives are forward contracts, interest rate swaps, futures, and options.
Interest rate swap: This is a type of derivative used by two parties under a contract to exchange the consequences (net cash difference between interest payments) of fixed interest rate for floating interest rate, or vice versa, without exchanging the principal or notional amounts.
Record the note payable as on January 1, 2019.
Date | Account titles and explanation | Debit ($) | Credit($) |
January 1, 2019 | Cash | $3,000,000 | |
Notes Payable | $3,000,000 | ||
(To record the note payable to bank) |
Table (1)
Record the interest payment on loan on December 31, 2019.
Date | Account titles and explanation | Debit ($) | Credit($) |
December 31, 2019 | Interest expenses | $210,000 | |
Cash | $210,000 | ||
(To record the payment of interest on $3 million bank loan) |
Table (2)
Working note (1):
Calculate the amount of interest paid on loan.
Record the interest rate swap receipt (payment) on December 31, 2019.
Date | Account titles and explanation | Debit ($) | Credit($) |
December 31, 2019 | Cash | $12,000 | |
Interest expenses | $12,000 | ||
(To record the interest rate swap receipt) |
Table (3)
Record the fair values and gains and losses on December 31, 2019.
Date | Account titles and explanation | Debit ($) | Credit($) |
December 31, 2019 | Loss in fair value of derivative | $53,497 | |
Liability from interest rate swap | $53,497 | ||
(To record the loss on derivative swap) |
Table (4)
Working note (2):
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, 2019 | Note payable (6) | $53,497 | |
Gain in value of debt | $53,497 | ||
(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 = 2, i =8% 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.
2.
Prepare the appropriate disclosures in Company A’s financial statements for 2019.
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.
Balance sheet: Balance Sheet is one of the financial statements that summarize the assets, the liabilities, and the Shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.
Prepare the appropriate disclosures in Company A’s financial statements for 2019.
Income statement:
Company A | |
Income statement | |
For The Year Ending December 31, 2019 | |
Particulars | Amount |
Other items: | |
Interest expense (7) | ($198,000) |
Loss in value of derivative | ($53,497) |
Gain in value of debt | $53,497 |
Table (6)
Working note (7):
Calculate the amount of interest expense to be reported in Income statement.
Balance sheet:
Company A | |
Balance sheet | |
As at December 31, 2019 | |
Liabilities | Amount |
Long term liabilities: | |
Notes payable (8) | $2,946,503 |
Liability from interest-rate swap | $53,497 |
Table (7)
Working note (8):
Calculate the amount of notes payable:
Want to see more full solutions like this?
Chapter 13 Solutions
Intermediate Accounting: Reporting And Analysis
- On 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_forwardHh1.arrow_forwardAbhaliyaarrow_forward
- Please help mearrow_forwardCompany B (CB) entered into an interest rate swap contract with Company C (CC) effective January 1, 2020. Specifically, CB agrees to pay CC’s interest and CC will pay CB’s interest. The contract lasts for three years. CB is attempting to hedge their cash flow risk exposure on their floating rate debt on a loan of $ 3,000,000 which is due in full in three years. CC is attempting to hedge their fair value risk exposure on their fixed rate debt of $ 3,000,000 which is also due in three years in full. The notional principal in the swap contract is $ 3,000,000. The fixed rate and variable rate on January 1, 2020 were both 5%. During 2020 the variable rate increased to 6 %. Required. (a) Prepare the journal entries for 2020 for CB and CC using IFRS and ASPE if optional hedge accounting is used. Explain your answer. (b) Prepare the journal entries for 2020 for CB and CC using IFRS and ASPE if optional hedge accounting is not used. Explain your answer.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
- help mearrow_forwardSagararrow_forwardOn January 1, 2021, JPS Industries borowed $220,000 from Austin Bank by issuing a three-year, floating rate note based on LIBOR, with interest payable semi-annually on June 30 and December of each year. JPS entered into a three-year interest rate swap agreement on January 1, 2021, and designaled the swap as a cash flow hedge. The intent was to hedge the risk that interest rates will rise, increasing its semi-annual interest payments. The swap agreement called for the company to receive payment based on a floating Interest rate on a notional amount of $220,000 and to pay a 4.0% fixed Interest rate. The contract called for cash settlement of the net interest amount semi-annually, and the rate on each reset date (June 30 and December 31) determines the variable interest rate for the following six months. LIBOR rates in 2021 were 4.0% at January 1, 3.0% at June 30, and 5.5% at December 31. The fair values of the swap on those dates, obtalned by dealer quotes, were as follows: January 1…arrow_forward
- 36) On January 2, 2025, Karr Company issued a 5-year, $6,000,000 note at LIBOR with interest paid annually. The variable rate is reset at the end of each year. The rate for the first year is 6.8%. Karr decides it prefers fixed- rate financing and wants to lock in a rate of 7%. As a result, Karr enters into an interest rate swap to pay 7% fixed and receive LIBOR based on $6 million. The variable rate is reset to 7.4% on January 2, 2026. What net interest expense will be reported for this note and the related swap transactions on Karr's 2026 income statement? 36) A) $444,000 B) $408,000 C) $420,000 D) $404,000arrow_forwardOn January 1, 20x1, ABC Co. obtained a five-year, ₱1,000,000 variable-rate loan with interest payments due at each year-end and the principal due on December 31, 20x5. As protection from possible fluctuations in current market rates, ABC Co. enters into an interest rate swap for the whole principal of the loan. Under the agreement, ABC Co. shall receive variable interest and pay fixed interest based on a fixed rate of 8%. Swap payments shall be made at each year-end. The following are the current market rates: Jan. 1, 20x1 8% Jan. 1, 20x2 9% Jan. 1, 20x3 12% 16. How much is the fair value of the interest rate swap on December 31, 20x1? (Indicate whether it is a derivative asset or liability.) a. 32,397 asset b. 32,397 liability c. 46,884 asset d. 53,223 liabilityarrow_forwardOn March 2021, Company A enters a forward rate agreement(FRA) with company B to borrow $1 million at 4% between October 2021 and December 2021(three months). The term structure of interest rates is flat at 5%. The value of the FRA contract for Company A isarrow_forward