Question

On January 1, 2018, LLB Industries borrowed $290,000 from trust Bank by issuing a two-year, 8% note, with interest payable quarterly. LLB entered into a two-year interest rate swap agreement on January 1, 2018, 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 8% fixed interest rate on a notional amount of $290,000 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 8% at January 1, 6% at March 31, and 4% June 30, 2018. The fair values of the swap are quotes obtained from a derivatives dealer. Those quotes and the fair values of the note are as indicated below. The additional rise in the fair value of the note (higher than that of the swap) on June 30 was due to investors’ perceptions that the creditworthiness of LLB was improving. January 1 March 31 June 30 Fair value of interest rate swap 0 $ 8,000 $ 14,094 Fair value of note payable $ 290,000 $ 298,000 $ 304,094 Required: 1. Calculate the net cash settlement at June 30, 2018. 2. Prepare the journal entries on June 30, 2018, to record the interest and necessary adjustments for changes in fair value.

Answer 1

Answer
1)	Net cash settlement at 30 June 2018
		Mar 31.	June 30.
	Fixed rate	8%	8%
	Floating rate	6%	4%
	Fixed interest (Quarterly interest )
	(290000*8%*3/12)	$                   5,800	$                   5,800
	Less; Floating interest	$                   4,350	$                   2,900
		(290000*6%*3/12)	(290000*4%*3/12)
	Net cash settlement	$                   1,450	$                   2,900
Journal entry
2)
Date	Account titles and explanation	Debit	Credit
01-01-2018	Cash	$                 23,200	$                 35,000
	To, Notes payable		$                 23,200
	( To record Notes issued)
31-03-2018	Interest expense(Fixed interest )	$                   4,350
	To, Cash		$                   4,350
	( To record Interest paid)
31-03-2018	Cash	$                   1,450
	To, Interest expense		$                   1,450
	(To record Net settlement recorded)
31-03-2018	Interest rate swap	$                   8,000
	To, Holding gain-interest rate swap		$                   8,000
	(To record change in fair value of derivative)
31-03-2018	Holding loss-hedged note (298000-290000)	$                   1,000
	To, Note payable		$                   1,000
	(To record change in fair value of note)
30-06-2018	Interest expense (Fixed interest )	$                   4,350
	To, Cash		$                   4,350
	(To record Interest paid)
30-06-2018	Cash	$                   3,500
	Interest expense		$                   3,500
	(Net settlement recorded)
30-06-2018	Interest rate swap (14,094-8000)	$                   6,094
	To,Holding gain-interest rate swap		$                   6,094
	(To record change in fair value of derivative)
30-06-2018	Holding loss-hedged note (304094-298000)	$                   6,094
	To,Note payable		$                   6,094
	(To record change in fair value of note)
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