Question

On January 1, 2021, Labtech Circuits borrowed $110,000 from First Bank by issuing a three-year, 9% note, payable on December 31, 2023. Labtech wanted to hedge the risk that general interest rates will decline, causing the fair value of its debt to increase. Therefore, Labtech entered into a three-year interest rate swap agreement on January 1, 2021, and designated the swap as a fair value hedge. The agreement called for the company to receive payment based on an 9% fixed interest rate on a notional amount of $110,000 and to pay interest based on a floating interest rate tied to LIBOR. The contract called for cash settlement of the net interest amount on December 31 of each year.

Floating (LIBOR) settlement rates were 9% at inception and 10%, 8%, and 8% at the end of 2021, 2022, and 2023, respectively. The fair values of the swap are quotes obtained from a derivatives dealer. These quotes and the fair values of the note are as follows:

	January 1			December 31
	2021			2021			2022			2023
Fair value of interest rate swap		0		$	(1,859	)	$	1,035		$	0
Fair value of note payable	$	110,000		$	108,141		$	111,035		$	110,000

Required:
1. Calculate the net cash settlement at the end of 2021, 2022, and 2023.
2. Prepare the journal entries during 2021 to record the issuance of the note, interest, and necessary adjustments for changes in fair value.
3. Prepare the journal entries during 2022 to record interest, net cash interest settlement for the interest rate swap, and necessary adjustments for changes in fair value.
4. Prepare the journal entries during 2023 to record interest, net cash interest settlement for the interest rate swap, necessary adjustments for changes in fair value, and repayment of the debt.
5. Calculate the book values of both the swap account and the note in each of the three years.
6. Calculate the net effect on earnings of the hedging arrangement in each of the three years. (Ignore income taxes.)
7. Suppose the fair value of the note at December 31, 2021, had been $107,000 rather than $108,141 with the additional decline in fair value due to investors’ perceptions that the creditworthiness of Labtech was worsening. How would that affect your entries to record changes in the fair values?
  

Answer 1

As per the HOMEWORKLIB RULES, Only First 4 subparts need to be solved. Please keep posted separately the remaining question....... I will be grateful to help you.

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Answer 2

Ans 1) a) Determine the Net cash settlement at the end of 2021 ffost compute fixed interest receipts. Notional Amount x Fixed Interest x Time = fixed Intent. Period Receipts. $110.000 x 9% $9.900 Rate x 1 Then compute floating interest Payments Notional Amount_x_floating Puterest x Time floating Rate Period Interest Paymente $110.000 $11,000 10% X 1 Compute Net Interest receipts or Net cash settlement.. Particularu Amount fined Interest Receipts $ 9,900 Floating Interest Payments (14,000) Net cash Settlement for year 2021 = $(1.100) Aus Hence, the Hence, the Net Cash of year 2021 end of Settlement at the $1,100) مل

Settlement for the Year b Determine Determine the Net cash 2022, first compute fixed Puferest Receipts . National Amount X Fixed Interest x Time Period Rate $110,000 9% fixed Interest Receipts. = $ 9,900 X X Then, Compute floating floating Duterest Payments. Notional Amount x Floating Interest x Time Periola floating Rate Interest Payments $ 110,000 X Х =$ 8,800 Compute the Net Cash settlement for 2022. Particulars Amount Fixed Interest Receipts $ 9,900 Floating Panterest Payments (8,800) Net cash settlement for Year 2022 ) $ 1,100 Aus Hence, the end the ol Net year Cash settlement at 2022 is $ 1,100

Determine the Net cash Settlement for the Year 2023 fixed Interest Receipts. Notional Amount * fined Beterest x Time Period = fixed Interest Rate Receipte $110,000 go% , = $9.900 first compute х x X 1 Then, compute the floating Puteriest Payments Nolfonal Amount x Floating Interest x Time period beton Rate floating Cos Interest Payments $110,000 84 = $ 8,800 ti Compute Net Cash Settlement for 2023. Particulars Amounts fisced Interest Receipts $9.900 Floating Panterest Payments (8,800) Net Cash Settlement for 2023 $LIDO the Aw Hence of the Net Cash settlement at the end year 2023 is $ 1,100

Credit 2) Jowinalize the transaction for 2021 Issue of Note Date Particulares Debit Jan 1, 2021 cash -Dr. $110,000 To Notes Payable To Record Resuance of Note ) $ 110,000 Interest Expense Payment Date Particulars Dec 31, , Interest Expense 2021 To cash Credit Debit Dr. $9,900 $ 9,900 ( (To record Interest Expense. Payment) . Net Patekut Receipt Date Particulars Dec 31 Interest Expense 2021 To cash. Debit Dr. $ 1,100 Credit $ 1.100 (To record Net Interst Settlement.

Credit Date 2021 changes in fair value of Interest slaap Particulars Debit Dec 31, Holding loss - Interest Rate Swap $ 21,859 To Interest Rate Swap (To record decrease in fair value from 'o'to (1,859) Dr. $ 1,859 credit . Changes in fair value of Note Date Account Titles & Explanation Debit Note Payable $ 1,859 To Holding gain- Hedged Dr. E Dec 31, 2021 $ 1,859 (To record decrease in value from $110,000 to $108, 142) for 2022. 3 Journalize Journalize the transaction Interest Expense Paymentu Date Account Title & Explanation, Debit Interest Expense Dr. $ 9,900 To Cash Credit Dec 34 2022 $ 9,900 (To record Interest Expense payment

Credit Dr. $ 1,100 Net Interest Receipt. Date Account Titles & Explanation Debit Dec 31, 2022 cash. $ 1.100 To Interest Expense ( (To record Net Interest Settlement) Credit Changes in fair value of Interest Swap. Date Account Titles & Explanation Debit Interest Rate Swap Dr. $ 2,894 To Holding gain. Interest Dec 3 2022 $2,894 pale swap To record decrease in Fair valde from $(1,859) to $1,035) [7,859+1,035 changes in fair value of Note Date Account Titles & Explanation Debit Dec 31,2022 Holding low- Hedged Note Desi $2,894 To Note Payable "To record decrease in value from $108,141 to $111,035) Credit $ 2,894

4 Journalize the transactions for 2023 Interest Expense Payment Debit credit Date Account Titles & Explanation Interest Expense Dr. $ 9,900 $9.900 Dec 31, 2023 To Cash [to record Puterest Expense Payment Credit Net Puterest Receipt Date Account Titles & Explanation Debit Decal Cash Dr. $ 1,100 To Puterest Expense (To record net Pinterest settlement) $ 1.100 2023 Changes in fair value of Interest Swap. Date Account Titles & Explanation Debit credit. Dec 31, Holding Las - Interest Rate Swap $ 1,035 To Interest Rate swap $ 1,035 (To record decrease in Fair value from 1,035 to 2023

Changes in fair value of Note Credit Date Decal, 2023 $1,035 Account Titles & Emplanation Debit Note Payable Dr. $4,035 To Holding guin- Hedged Noke To record decrease in value from $111,035 to $110,000) Repayment of Note. Date Account Titles & Explanatio Debit Dr $110,000 To Cash on credit Dec 34 2023 Note Payable $110,000 ( (To record. Note being Paid).

As per the Chegg guidelines, Only First 4 subparts need to be solved. Please keep posted separately the remaining question....... I will be grateful to help you.

Please give a positive ratings........................ Your ratings will be helpful for me. If you have any query regarding this solution please comment below. I will be grateful to help you. Thank you!