Problem 19-41 Derivatives: Accounting for Swaps On January 1, 2015 Nathan Compan
ID: 2557432 • Letter: P
Question
Problem 19-41 Derivatives: Accounting for Swaps On January 1, 2015 Nathan Company received a five year, $5,000,000 loan with interest payments occurring at the end of the year and the principal to be repaid on December 31, 2019. The interest rate for the first year is the prevailing market rate of 8% and the rate in each succeeding year will be equal to the market interest rate on January 1 of that year. In conjunction with this loan, Nathan enters into an interest rate swap agreement whereby, in each year of the loan starting with 2016, Nathan will receive a swap payment (based on $5,000,000) if the January 1 interest rate is more than 8% and will make a swap payment if the rate is less than 8%. The swap payments are made at the end of the year. On January 1, 2016, the interest rate is 11% and on December 31, 2016, the interest rate is 7%. Instructions: Make all journal entries necessary on Nathan's books in 2015 and 2016 to record this loan and the interest rate swap. For purposes of estimating future swap payments, assume that the current interest rate is the best forecast of the future interest rate.
Explanation / Answer
SOLUTION:
Particulars Debit Credit Jan-01 Cash 5,000,000 Loan Payable 5,000,000 Dec-31 Interest Expense 400,000 Cash ($5,000,000*0.08) 400,000 Interest Rate Swap (asset) 465,367 Other Comprehensive Income 465,367 5,000,000*(0.11 – 0.08) = 150,000 (PMT = $150,000, N =4, I = 11% 2016 Dec-31 Interest Expense 550,000 Cash ($5,000,000 * 0.11) 550,000 Cash (from swap agreement) 150,000 Interest Rate Swap (net asset) 150,000 5,000,000*(0.11 – 0.08) = 150,000 Accumulated Other Comprehensive Income 150,000 Interest Expense 150,000 Other Comprehensive Income 446,583 Interest Rate Swap (net liability) 446,583 ($5,000,000(0.08 – 0.07)) = 50,000 (PMT = $50,000, N =3, I = 7% = 131,216 465,367-150,000+131,216