Question

On January 1, 2020, Miron Ltd. issues a floating rate bond for $ 500,000. At the same time, the corporation enters into an interest rate swap whereby it agrees to pay interest on $ 500,000 at 10% (the current interest rate) and to receive payments based on the floating rate. At December 31, 2020, the floating interest rate is 8%, and the value of the swap contract is $ 40,000 to the counterparty’s benefit.

Prepare any journal entries required related to the swap agreement and the interest payment on the bond.

a)      January 1, 2020

b)      December 31, 2020 – interest payment on the bond

c)       December 31, 2020 –Payment of swap interest (net)

d)      December 31, 2020 –Record swap contract asset/liability.

Answer 1

When two parties enter into an agreement to exchange the interest rates , it is called as interest rate swap. The swap will be done by two parties , one of whom needs a fixed rate of interest to minimise risks and the other needs a variable rate of interest or floating rate of interest .

In the given question, Miron has issued the floating rate bond worth $5,00,000.

IT has decided to pay fixed interest @ 10% p.a  and receive floating rate interest which was @ 8% p.a at the year end .

Journal entries for MIRON, Interest rate swap

Date	Description	Debit $	Credit  $
2020 Jan 1	Cash Bonds payable Recorded Bonds issued	$ 5,00,000	$ 5,00,000
Jan 1	No entry for entering swaps as no exchange of cash has been made
Dec 31	Interest Expense    Cash Recorded the linterest paid on bonds payable (5,00,000 x 8/100)	$40,000	$ 40,000
Dec 31	Interest Expense ( Loss on Swap) Cash Recorded the loss on interest swap	$10,000	$ 10,000
Dec 31	Bonds To Gain on hedge   Recorded the change in the fair value of the debt due to decrease im rate of interest (5,00,000 x 2/100)	$10,000	$10,000
Dec 31	Loss on Hedge Swap contract Being loss incurred due to payment of excess rate of interest (5,00,000 x (10-8)%	$10,000	$10,000

As on 31.12.2020

Interest paid @ 10% on $ 5,00,000 =$50,000 ( fixed)

Interest received @ 8% on $ 5,00,000 =$40,000 ( floating)

Loss on swap =$10,000