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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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BuyFindarrow_forward

Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem

(Appendix 13.1) Derivatives Anglar Company has a $3 million, 7% bank loan from Castle Rock Bank. On January 1, 2019, when the $3 million loan has 3 years remaining, Anglar contracts with Susan Investment Bank to enter into a 3-year interest rate swap with a $3 million notional amount. Anglar agrees to receive from Susan a fixed interest rate of 7% and to pay Susan an interest amount each year that is variable based on the LIBOR interest rate at the beginning of the year. The interest payments are made at year-end. The applicable interest rate on the swap is reset each year after the annual interest payment is made. The LIBOR interest rate is 6.6% at the beginning of 2019. The 3-year fixed interest rate is 8% at December 31, 2019.

Required:

  1. 1. Prepare the journal entries of Anglar for the bank loan and derivative for 2019. Round answers to the nearest dollar.
  2. 2. Prepare the appropriate disclosures in Anglar’s financial statements for 2019.

1.

To determine

Prepare the journal entries in the books of Company A for the bank loan and derivative for 2019.

Explanation

Derivatives: Derivatives are some financial instruments which are meant for managing risk and safeguard the risk created by other financial instruments. These financial instruments derive the values from the future value of underlying security or index. Some examples of derivatives are forward contracts, interest rate swaps, futures, and options.

Interest rate swap: This is a type of derivative used by two parties under a contract to exchange the consequences (net cash difference between interest payments) of fixed interest rate for floating interest rate, or vice versa, without exchanging the principal or notional amounts.

Record the note payable as on January 1, 2019.

DateAccount titles and explanationDebit ($)Credit($)
January 1, 2019Cash$3,000,000 
 Notes Payable $3,000,000
 (To record the note payable to bank)  

Table (1)

Record the interest payment on loan on December 31, 2019.

DateAccount titles and explanationDebit ($)Credit($)
December 31, 2019Interest expenses$210,000 
 Cash $210,000
 (To record the payment of interest on $3 million bank loan)  

Table (2)

Working note (1):

Calculate the amount of interest paid on loan.

Interest paid on loan = Loan payable ×Interest rate on bank loan=$3,000,000×7%=$210,000

Record the interest rate swap receipt (payment) on December 31, 2019.

DateAccount titles and explanationDebit ($)Credit($)
December 31, 2019Cash$12,000 
 Interest expenses [(7%6.6%)×$3 million] $12,000
 (To record the interest rate swap receipt)  

Table (3)

Record the fair values and gains and losses on December 31, 2019.

DateAccount titles and explanationDebit ($)Credit($)
December 31, 2019Loss in fair value of derivative$53,497 
 Liability from interest rate swap $53,497
 (To record the loss on derivative swap)  

Table (4)

Working note (2):

Calculate the present value.

Present value =[(Market fixed interest rateInterest rate on swap)×Loan×Factor on present value of ordinary annuity]=[(8%7%)×$3,000,000×POn=2,i=8%]=[1%×$3,000,000×1

2.

To determine

Prepare the appropriate disclosures in Company A’s financial statements for 2019.

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