Question

On December 31, 2017, Mercantile Corp. had a $10,000,000, 8% fixed-rate note outstanding, payable in 2 years. It decides to enter into a 2-year swap with Chicago First Bank to convert the fixed-rate debt to variable-rate debt. The terms of the swap indicate that Mercantile will receive interest at a fixed rate of 8% and will pay a variable rate equal to the 6-month LIBOR rate, based on the $10,000,000 amount. The LIBOR rate on December 31, 2017, is 7%. The LIBOR rate will be reset every 6 months and will be used to determine the variable rate to be paid for the following 6-month period.

Mercantile Corp. designates the swap as a fair value hedge. Assume that the hedging relationship meets all the conditions necessary for hedge accounting. The 6-month LIBOR rate and the swap and debt fair values are as follows:

Date	6-month LIBOR	Swap Fair Value	Debt Fair Value
December 31, 2017	7%	---	$10,000,000
June 30, 2018	7.5%	(200,000)	$9,800,000
December 31, 2018	6%	60,000	10,060,000

Prepare the journal entries for:

(a) 6/30/2018

(b) 12/31/2018

Answer 1

Record the semiannual debt interest payment on June 30, 2018		All in $
Interest expense	400,000.00
To Cash(10000000*8%*6/12)		400,000.00
	Interest received
Swap recievable(10000000*8%*6/12)	400,000
Less: Payable at LIBOR(10000000*7%*6/12)	350,000
Cash settlement	50,000
Record the settlement of semiannual swap amount receivable on June 30, 2018
Cash	50,000
To Interest expense		50,000
Record the change in the fair value of the debt on June 30, 2018
Notes payable	200,000
To unrealized holding gain or loss-Income		200,000
Record the change in the fair value of the swap on June 30, 2018
Unrealized holding gain or loss-Income	200,000
to Swap contract		200,000
Record the semiannual debt interest payment on December 31, 2018		All in $
Interest expense	400,000.00
To Cash(10000000*8%*6/12)		400,000.00
	Interest received
Swap recievable(10000000*8%*6/12)	400,000
Less: Payable at LIBOR(10000000*7.5%*6/12)	375,000
Cash settlement	25,000
Record the settlement of semiannual swap amount receivable on June 30, 2018
Cash	25,000
To Interest expense		25,000
Record the change in the fair value of the debt on June 30, 2018
Unrealized holding gain or loss-Income	60,000
To Notes payable		60,000
Record the change in the fair value of the swap on June 30, 2018
Swap contract	60,000
to Unrealized holding gain or loss-Income		60,000