Question

On January 1, 2021, LLB Industries borrowed $280,000 from Trust Bank by issuing a two-year, 10% note, with interest payable quarterly. LLB entered into a two-year interest rate swap agreement on January 1, 2021, 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 10% fixed interest rate on a notional amount of $280,000 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 10% at January 1, 8% at March 31, and 6% at June 30, 2021. The fair values of the swap are quotes obtained from a derivatives dealer. Those quotes and the fair values of the note are as follows:

	January 1			March 31			June 30
Fair value of interest rate swap		0		$	7,800		$	13,794
Fair value of note payable	$	280,000		$	287,800		$	293,794

Required:
Prepare the journal entries through June 30, 2021, to record the issuance of the note, interest, and necessary adjustments for changes in fair value. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field. Round your intermediate and final answers to the nearest whole dollar.)

Answer 1

SOLUTION:

Date	Account titles and explanation	Debit	Credit
Jan 1.	Cash	$280,000
	Notes payable		$280,000
	(To record Notes issued)
Mar 31.	Interest expense	$ 7,000
	Cash		$ 7,000
	(To record Interest paid)
	Cash	$    1,400
	Interest expense		$    1,400
	(To record Net settlement)
	Interest rate swap	$ 7,800
	Holding gain-interest rate swap		$ 7,800
	(To record change in fair value of derivative)
	Holding loss-hedged note	$ 7,800
	Note payable (287,800-280,000)		$ 7,800
	(To record change in fair value of note)
June 30.	Interest expense	$ 7,000
	Cash		$ 7,000
	(To record Interest paid)
	Cash	$ 2,800
	Interest expense		$ 2,800
	(To record Net settlement)
	Interest rate swap	$ 5,994
	Holding gain-interest rate swap (13,794-7,800)		$ 5,994
	(To record change in fair value of derivative)
	Holding loss-hedged note	$ 5,994
	Note payable (293,794-287,800)		$ 5,994
	(To record change in fair value of note)

Workings:

Interest to be calculated on a notional amount of $ 280,000
	Mar 31.	June 30.
Fixed-rate	10%	10%
Floating rate	8%	6%
Fixed interest
(280,000*10%*3/12)	$ 7,000	$ 7,000
Less; Floating interest	$ 5,600	$ 4,200
(280000*8%*3/12)
Net cash settlement	$                  1,400	$ 2,800