On January 1, 2021, Labtech Circuits borrowed $250,000 from First Bank by issuing a three-year, 6% note, payable on Dece
Posted: Sun Jul 03, 2022 12:57 pm
On January 1, 2021, Labtech Circuits borrowed $250,000 fromFirst Bank by issuing a three-year, 6% note, payable on December31, 2023. Labtech wanted to hedge the risk that general interestrates will decline, causing the fair value of its debt to increase.Therefore, Labtech entered into a three-year interest rate swapagreement on January 1, 2021, and designated the swap as a fairvalue hedge. The agreement called for the company to receivepayment based on an 6% fixed interest rate on a notional amount of$250,000 and to pay interest based on a floating interest rate tiedto LIBOR. The contract called for cash settlement of the netinterest amount on December 31 of each year.Floating (LIBOR) settlement rates were 6% at inception and 7%, 5%,and 5% at the end of 2021, 2022, and 2023, respectively. The fairvalues of the swap are quotes obtained from a derivatives dealer.These quotes and the fair values of the note are as follows:
Required:1. Calculate the net cash settlement at theend of 2021, 2022, and 2023.2. Prepare the journal entries during 2021 torecord the issuance of the note, interest, and necessaryadjustments for changes in fair value.3. Prepare the journal entries during 2022 torecord interest, net cash interest settlement for the interest rateswap, and necessary adjustments for changes in fair value.4. Prepare the journal entries during 2023 torecord interest, net cash interest settlement for the interest rateswap, necessary adjustments for changes in fair value, andrepayment of the debt.5. Calculate the book values of both the swapaccount and the note in each of the three years.6. Calculate the net effect on earnings ofthe hedging arrangement in each of the three years. (Ignore incometaxes.)7. Suppose the fair value of the note atDecember 31, 2021, had been $237,000 rather than $246,741 with theadditional decline in fair value due to investors’ perceptions thatthe creditworthiness of Labtech was worsening. How would thataffect your entries to record changes in the fair values?
Complete this question by entering your answers in thetabs below.
Suppose the fair value of the note at December 31, 2021, hadbeen $237,000 rather than $246,741 with the additional decline infair value due to investors’ perceptions that the creditworthinessof Labtech was worsening. How would that affect yourentries to record changes in the fair values? (If no entry isrequired for a transaction/event, select "No journal entryrequired" in the first account field.)
Required:1. Calculate the net cash settlement at theend of 2021, 2022, and 2023.2. Prepare the journal entries during 2021 torecord the issuance of the note, interest, and necessaryadjustments for changes in fair value.3. Prepare the journal entries during 2022 torecord interest, net cash interest settlement for the interest rateswap, and necessary adjustments for changes in fair value.4. Prepare the journal entries during 2023 torecord interest, net cash interest settlement for the interest rateswap, necessary adjustments for changes in fair value, andrepayment of the debt.5. Calculate the book values of both the swapaccount and the note in each of the three years.6. Calculate the net effect on earnings ofthe hedging arrangement in each of the three years. (Ignore incometaxes.)7. Suppose the fair value of the note atDecember 31, 2021, had been $237,000 rather than $246,741 with theadditional decline in fair value due to investors’ perceptions thatthe creditworthiness of Labtech was worsening. How would thataffect your entries to record changes in the fair values?
Complete this question by entering your answers in thetabs below.
Suppose the fair value of the note at December 31, 2021, hadbeen $237,000 rather than $246,741 with the additional decline infair value due to investors’ perceptions that the creditworthinessof Labtech was worsening. How would that affect yourentries to record changes in the fair values? (If no entry isrequired for a transaction/event, select "No journal entryrequired" in the first account field.)