Question

Exercise A-6 Derivatives; interest rate swap; fixed-rate debt; fair value change unrelated to hedged

On January 1, 2018, LLB Industries borrowed $290,000 from trust Bank by issuing a two-year, 8% note, with interest payable quarterly. LLB entered into a two-year interest rate swap agreement on January 1, 2018, and designated the swap as a fair value hedge. Its intent was to hedge the risk that general interest rates will decline, causing the fair value of its debt to increase. The agreement called for the company to receive payment based on a 8% fixed interest rate on a notional amount of $290,000 and to pay interest based on a floating interest rate. The contract called for cash settlement of the net interest amount quarterly.

Floating (LIBOR) settlement rates were 8% at January 1, 6% at March 31, and 4% June 30, 2018. The fair values of the swap are quotes obtained from a derivatives dealer. Those quotes and the fair values of the note are as indicated below. The additional rise in the fair value of the note (higher than that of the swap) on June 30 was due to investors’ perceptions that the creditworthiness of LLB was improving.

	January 1	March 31	June 30
Fair value of interest rate swap	0	8,000	14,094
Fair value of note payable	290,000	298,000	304,094

Net cash settlement at June 30 $2,900

Prepare journal entries at June 30

Record interest

Record the net cash settlement, accrued interest on the swap, and change in fair value of the derivative

record the change in fair value of the note due to interest

Answer 1

on June 200h for interest 5 800 5 800 - Interest expense alu. os TO Accoued satellst du (9.90.000 x 8%. * 3/12 Anteet on emme - Accrued interest alur Dg on To interest al... COD (290.000 x 27 x 3/13] 2900 2900 Net cash settlement cash alu Accud intesest alu.. Di 2900 To cash alo. 2900 Change in fair value of dent 08 6094 loss on hedge activity alu. 10 Noli payable 3.04.094 - 8.98 000] 6094 change in fair value of swap swap contract alu.. DR 6094. 10 Gainm hedgu activity 04094 - 8000] 6094 S ong