Question

Beaver Inc. issues a 5,000,000 5-year, 8% fixed-rate interest note payable on December 31, 2020. Beaver Inc. is worried that interest rates may decrease which would increase the value of its debt so it enters into a swap agreement with Lion Corp. The swap agreement specifies that Beaver Inc. will receive a fixed rate at 8% and pay a variable (floating) rate with settlement dates occurring on the dates interest payments are due. Interest payments are due annually on December 31st. This hedge is classified as a fair value hedge.

Required:

1. During 2021, market interest rates decreased to 6%. Which journal entries does Beaver Inc. record on December 31, 2021 to account for interest and the swap arrangement?

2. During 2022, market interest rates increased from 6% to 7%. What journal entries does Beaver Inc. record on December 31, 2022 to account for interest and the swap arrangement?

3. What is the total income statement effect of the note payable and associated interest rate swap for the fiscal year ending on December 31, 2022?

Answer 1

loan amount 500000, 5yr, @8% fixed

swap agreement entered where

we receive fixed@8%, we pay variable (floating rate as on date of payment), annually on 31/12

1.during 2021 journal entry for interest and swap arrangement when the floating rate is 6%

31/12/2021. Interest expense Dr. 300,000 (5,000,000*6%)

To cash 300,000

31/12/2021   Cash Dr 400,000 (5,000,000*8%)

To interest expense 400,000

2. during 2022 journal entry for interest and swap arrangement when the floating rate is 7%

31/12/2022. Interest expense Dr. 350,000 (5,000,000*7%)

To cash 350,000

31/12/2021 Cash Dr 400,000 (5,000,000*8%)

To interest expense 400,000

3. the total income statement effect of the note payable and associated interest rate swap for the fiscal year ending on December 31, 2022

we paid cash $350,000 (5,000,000*7%)

we received cash of $400,000 (5,000,000*8%)

net cash received is $50,000