Question

As of 12/31/19, Bayern Corp. had a $100M 3% (annual) fixed-rate note outstanding which is payable on 12/31/23. On 1/1/20, Bayern decides to enter into a 4-year interest rate swap with Juventus Bank. Bayern will receive fixed payments (of 3%, annual) and pay a variable rate based on LIBOR. Assume that interest payments on the note and settlement on the rate exchange are semiannual. The LIBOR-based rate on 1/1/20 is also 3% (annual). The LIBOR-based variable rate is reset every 6 months to determine the variable rate for the subsequent 6 months.

Bayern designates the swap as a fair value hedge and the hedge is deemed highly effective. The swap has no value at inception. Annual LIBOR-based rates, and swap and note fair values are indicated below. Assume that Bayern makes fair value adjustments every 6 months.

Annual LIBOR-

Date               based rate            Swap Fair Value     Note Fair Value

6/30/20               2.9%                 $330,552    $100,330,552

12/31/20             3.1%    ($284,375)          $ 99,715,625

6/30/21            3.05%                 ($119,479)            $ 99,880,521

Required: Present the journal entries for the following dates/transactions:

(a) The entry to record the semiannual interest payment on the note on 6/30/20.

(b) The entry to record the fair value adjustments to the note and swap on 6/30/20.

(c) The entry to record the semiannual interest payment on the note and the settlement of the interest rate swap on 12/31/20.

(d) The entry to record the fair value adjustments to the note and swap on 12/31/20.

(e) The entry to record the semiannual interest payment on the note and the settlement of the interest rate swap on 6/30/21.

(f) The entry to record the fair value adjustments to the note and swap on 6/30/21.

Answer 1

A	Principal value of note	100000000
B	Interest rate p.a	3%
C	Interest rate semi annual	1.50%
D	Interest payment semi annual (A*C)	1500000

(a) The entry to record the semiannual interest payment on the note on 6/30/20-

Interest expense A/c Dr.             $1500000

                To Accrued Interest Payable A/c                                $1500000

( Being interest payment payable on the note on 30.06.20)

Accrued Interest Payable A/c Dr.             $1500000

                To Cash A/c                                                        $1500000

(Being Interest accrued paid by cash)

(b) The entry to record the fair value adjustments to the note and swap on 6/30/20-

Principal value of note	100000000
Fair value of note on 30.06.20	100330552
Loss	330552

Loss on Hedging activity A/c Dr.                 $330552

                To 3% Fixed rate Note A/c                           $330552

This loss is offset by gain on interest rate swaps-

Swap Contract A/c Dr.                    $330552

                To Gain on Hedge activity A/c                     $330552

(c) The entry to record the semiannual interest payment on the note and the settlement of the interest rate swap on 12/31/20-

Interest payment on Note-

Interest expense A/c Dr.             $1500000

                To Accrued Interest Payable A/c                                $1500000

( Being interest payment payable on the note on 31.12.20)

Accrued Interest Payable A/c Dr.             $1500000

                To Cash A/c                                                        $1500000

(Being Interest accrued paid by cash)

Settlement of Swap-

A	Fixed rate( receivable)	3%
B	Variable rate(LIBOR)	3.10%
C	Net payable(B-A)	0.10%
D	Net payable semi annual(C/2)	0.05%
E	Interest payable on Swap as on 31.12.20($100 million*0.05%)	50000

Interest Expense A/c Dr.     $50000

            To Cash A/c                          $50000

(d) The entry to record the fair value adjustments to the note and swap on 12/31/20-

Fair value of note on 30.06.20	100330552
Fair value of note on 31.12.20	99715625
Gain	614927

3% Fixed rate Note A/c Dr.                          $614927

                To Gain on Hedge activity A/c                     $614927

This gain is offset by loss on interest rate swaps-

Loss on Hedging activity A/c Dr.                 $614927

                To Swap Contract A/c                                     $614927

(e) The entry to record the semiannual interest payment on the note and the settlement of the interest rate swap on 6/30/21-

Interest payment on note-

Interest expense A/c Dr.             $1500000

                To Accrued Interest Payable A/c                                $1500000

( Being interest payment payable on the note on 30.06.21)

Accrued Interest Payable A/c Dr.             $1500000

                To Cash A/c                                                        $1500000

(Being Interest accrued paid by cash)

Settlement of Swap-

A	Fixed rate( receivable)	3%
B	Variable rate(LIBOR)	3.05%
C	Net payable(B-A)	0.05%
D	Net payable semi annual(C/2)	0.025%
E	Interest payable on Swap as on 30.06.21($100 million*0.05%)	25000

Interest Expense A/c Dr.     $25000

            To Cash A/c                          $25000

(f) The entry to record the fair value adjustments to the note and swap on 6/30/21-

Fair value of note on 31.12.20	99715625
Fair value of note on 30.06.21	99880521
Loss	164896

Loss on Hedging activity A/c Dr.                 $164896

                To 3% Fixed rate Note A/c                           $164896

This loss is offset by gain on Interest rate swaps-

Swap Contract A/c Dr.                    $164896

                To Gain on Hedge activity A/c                     $164896