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On January 1, 2011, Labtech Circuits borrowed $100,000 from First Bank by issuing a three-year, 8% note, payable on December 31, 2013. 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, 2011, and designated the swap as a fair value hedge. The agreement called for the company to receive payment based on an 8% fixed interest rate on a notional amount of $100,000 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 8% at inception and 9%, 7%, and 7% at the end of 2011, 2012, and 2013, 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:


Required:

1.find out the net cash settlement at the end of 2011, 2012, and 2013.
2.Prepare the journal entries during 2011 to record the issuance of the note, interest, and necessary adjustments for changes in fair value.
3.Prepare the journal entries during 2012 to record interest, net cash interest settlement for the interest rate swap, and necessary adjustments for changes in fair value.

 

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  • Category:- Accounting Basics
  • Reference No.:- M942801

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