Question

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Exercise A-9 (Algo) Derivatives; cash flow hedge; interest rate swap; shortcut method (LOA-3] Kipped On January 1, 2021, JPS Industries borrowed $320,000 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 designated 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 $320,000 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. Book LIBOR rates in 2021 were 4.0% at January 1, 3.0% at June 30, and 5.0% at December 31. The fair values of the swap on those dates, obtained by dealer quotes, were as follows: Ask Swap fair value January 1 $ June 30 December 31 $(3,500) $ 4,400 Print Required: 1. Calculate the net settlement on June 30, 2021. 2. Prepare journal entries for the period January 1 to December 31, 2021, to record the note payable and hedging instrument, necessary adjustments for changes in fair value, and settlement of the swap contract. erences Complete this question by entering your answers in the tabs below. Required 1 Required 2 Calculate the net settlement on June 30, 2021. (Round your intermediate and final answer to the nearest whole dollar.) June 30 Net cash settlement < Required 1 Required 2 >

Answer 1

Above asked to determine the net cash settlement and preparation of journal entries for the period Jan 1 to Dec 31, 2021. Refer the below images for more detailed solution.

solution : O calculation of the net settlement on June 30, 2021 * June 30 particulars Amount $ 6400 Receive floating interest ($320000 X 44-x />) pay fixed interest (4 326000 x 47. */) Net cash receipt (payment) & (640) so * December 31 particulars Arcont Receive $ 4800 floating interest ($320000 x 34 x 11a). interest 4 320000 441x112) pay fixed $ (6400) Net cash payment $ (1600) • preparation af journal entries for the perrod jani to Dec 31, 2020 Date particulars Debit cyedit Jani 32.000 Cash All or To Notes payable Ak (Being to record the debt). 320000

Date particulars Debit credit June 30 ale or $ 6400 Interest expense To cosh Alc (Being to record 46400 interest on the note) Working : Interest expense $320000 X 44 X = 6400 June Jo $3500 3500 # 3500 other comprehensive income (GCE) AIC To Interest rate swap Alc. ( Being to record the change in the fair value of the derivative) $ 3500 - 80 = & 3500 Note point: At June 30, 2021, there is no cash exchanged for Settlement of the interest rate swap, because the cost Settlement is based on beginning of years rates, (when both the fixed and floating rate were 46) Daley does recognise a decrease in the far value of the interest rate swap, related to the deckning interest rates in the upcoming sit decrease in fair value is recognized in other Comprehensive income.

Date Debit Dec 31 credit particulars Interest expense Alc Dr TO Cash Alc (Being to record interest $4800 $ 4800 on the note) worlking : Interest expense - 4 320000 31-X112 • $4800 $ 1600 Dec 31 & 1600 Interest expense ale Dr To cash Arc (Bling to record the net on the swap). cash settlement working & cash = [(4-17$320000+ 112) - $4800] = $ 6400 - § 4800 = 1600 Decal $7900 Interest rate Swap Alc or $7900 To other comprehensive income Lock) ( Bring to record the Change in the fair value of the dexovative) 6 $ 3500 + $ 4400 = $ 7900 June 30 Dec 31 (swap fair value)