On January 1, 2016, S&S Corporation invested in LLB Industries’ negotiable two-y
ID: 2720688 • Letter: O
Question
On January 1, 2016, S&S Corporation invested in LLB Industries’ negotiable two-year, 10% notes, with interest receivable quarterly. The company classified the investment as available-for-sale. S&S entered into a two-year interest rate swap agreement on January 1, 2016, 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 investment to increase. The agreement called for the company to make payment based on a 10% fixed interest rate on a notional amount of $380,000 and to receive 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% June 30, 2016. The fair values of the swap are quotes obtained from a derivatives dealer. Those quotes and the fair values of the investment in notes are as follows:
January 1 March 31 June 30
Fair value of interest rate swap 0 $ 8,272 $ 14,994
Fair value of note payable $ 380,000 $ 388,272 $ 394,994
Required:
1. Calculate the net cash settlement at March 31 and June 30, 2016.
2. Prepare the journal entries through June 30, 2016, to record the investment in notes, 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.)
Explanation / Answer
Answer
Answer 1
Net Cash Settlement
March 31, 2016 = $ 380,000 * (10% - 8% ) * 3/12
=$ 1900
June 30, 2016 = $ 380,000 * (10% - 6%) * 3/12
. = $ 3800
Answer 2
Journal Entries
January 1, 2016
Investment in LLB Industries Notes A/c Dr. $ 380,000
To Cash A/c Cr. $ 380,000
31 March, 2016
Cash A/c Dr. $ 9500 ( $ 380,000 * 10% * 3/12)
To Interest income A/c Cr. $ 9500
Investment in LLB Industries Notes A/c Dr. $ 8,272 ( $ 388,272 - $ 380,000)
To Fair value Reserve A/c Cr. $ 8,272
Loss on Swap Hedge A/c Dr. $ 8,272
To Swap Hedge A/c Cr. $ 8,272
Settlement Interest A/c Dr. $ 1900 (As calculated in Answer 1 above)
To Cash A/c Cr. $ 1900
June 30, 2016
Cash A/c Dr. $ 9500 ( $ 380,000 * 10% * 3/12)
To Interest income A/c Cr. $ 9500
Investment in LLB Industries Notes A/c Dr. $ 6722 ($ 394,994 - $ 388,272)
To Fair value Reserve A/c Cr. $ 6722
Loss on Swap Hedge A/c Dr. $ 6722
To Swap Hedge A/c Cr. $ 6722
Settlement Interest A/c Dr. $ $ 3800 (As calculated in Answer 1 above)
To Cash A/c Cr. $ $ 3800
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