Question

P9.14 Interest Rate Swap: Journal Entries and Valuation Johnson & Johnson (J&J) has $10,000,000 of floating rate debt, with interest at LIBOR + 120 bp adjusted quarterly, and an equivalent amount of 2-year fixed-rate debt investments yielding 4 percent annually. J&J classifies the investments as held-to-maturity. To match fixed rate financing with its fixed-rate investments, J&J swaps 3 percent fixed payments to intermediary in exchange for LIBOR + 120 bp on the notional amount of $10,000,000 for 2 years, and designates the investments as the hedged item. LIBOR is 1.8 percent.

Prepare the entries made by J&J at the end of the first and second quarter to record interest expense

Answer 1

			notional amount	interest (annually)	interest (quaterly)	interest paid in march	interest paid in june	interest reduction
FIXED RATE to swap(annually)		3%	10,000,000.00	300,000.00	75,000.00	225,000.00	225,000.00	75,000.00
LIBOR+120bp	1.8+1.2=	3%	10,000,000.00		300,000.00
120bp=120/100	1.20

Johnson & Johnson
JOURNAL ENTRIES
DATE	ACCOUNT	DEBIT	CREDIT
MARCH 31	Interest expense	225000
	CASH		225000
	CASH	75000
	Interest expense		75000
JUNE 30	Interest expense	225000
	Cash		225000
	CASH	75000
	Interest expense		75000