Question

On January 2, 2020, Pharoah Corp. issues a $8–million, five–year note at LIBOR, with interest paid annually. To protect against the cash flow uncertainty related to interest payments that are based on LIBOR, Pharoah entered into an interest rate swap to pay 8% fixed and receive LIBOR based on $8 million for the term of the note. The LIBOR rate for the first year is 7.6%. The LIBOR rate is reset to 8.7% on January 2, 2021. Pharoah follows ASPE and uses hedge accounting. On December 31, 2020, the fair value of the swap decreased by $13,500: it increased by $4,000 on December 31, 2021. Assume that the criteria for hedge accounting under ASPE are met.

Prepare the journal entries to recognize the swap, assuming the company follows hedge accounting under IFRS

December 31, 2020( to decrease the value of the contract)

December 31,2020 (To record the fix under hedge accounting)

December 31,2022( To record the value of the contract)

December 31, 2022(k To record the fix under hedge accounting)

Answer 1

Per the information provided in question, we have noted the following

Notes issued = $8 million

Fixed interest rate - 8%

Variable interest rate - 7.6% (as on Jan 2, 2020) and 8.7% (as on Jan 2, 2021)

Gains/losses due to interest rate swaps is as follows.

Interest Types 2020 2021

Variable $608,000 (8,000,000*7.6%)   $696,000 (8,000,000*8.7%)

Fixed $640,000 (8,000,000*8%)   $640,000 (8,000,000*8%)

Difference $(32,000) $56,000

Therefore, as of 12/31/2020 the Pharoah has to pay excess interest of $32,000 whereas as of 12/31/2021 the Pharoah will receive an interest amount of $56,000

Journal Entries as on 12/31/2020

1) Dr Interest Expense account $608,000

Cr Cash $608,000

(To Pay the interest expense at LIBOR 7.6%)

2) Dr Interest Expense account $32,000

Cr Cash $32,000

(To fix the interest exp under hedge accounting)

3) Dr Other Comprehensive income $13,500

Cr Swap Contract $ 13,500

(To record the decrease in the swap contract)

Journal Entries as on 12/31/2021

1) Dr Interest Expense account $696,000

Cr Cash $696,000

(To Pay the interest expense at LIBOR 8.7%)

2) Dr Cash $32,000

Cr Interest Expense account     $32,000

(To fix the interest exp under hedge accounting)

3) Dr Swap Contract     $4,000

Cr Other Comprehensive income $ 4,000

(To record the increase in the swap contract)