P17-16 (Fair Value Hedge Interest Rate Swap) On December 31, 2014, Mercantile Co
ID: 2416962 • Letter: P
Question
P17-16 (Fair Value Hedge Interest Rate Swap) On December 31, 2014, 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 8.0% 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, 2014, 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. Instructions Prepare the journal entries for the following transactions. (a) April 1, 2014—Inception of the futures contract, no premium paid. (b) June 30, 2014—LEW Co. prepares financial statements. (c) September 30, 2014—LEW Co. prepares financial statements. (d) October 10, 2014—LEW Co. purchases 500 ounces of gold at $315 per ounce and settles the futures contract. (e) December 20, 2014—LEW sells jewelry containing gold purchased in October 2014 for $350,000. The cost of the finished goods inventory is $200,000. (f) Indicate the amount(s) reported on the balance sheet and income statement related to the futures contract on June 30, 2014. (g) Indicate the amount(s) reported in the income statement related to the futures contract and the in-ventory transactions on December 31, 2014. *P17-18 (Fair Value Hedge) On November 3, 2014, Sprinkle Co. invested $200,000 in 4,000 shares of the common stock of Pratt Co. Sprinkle classified this investment as available-for-sale. Sprinkle Co. is consid-ering making a more significant investment in Pratt Co. at some point in the future but has decided to wait and see how the stock does over the next several quarters. Instructions (a) Present the journal entries to record the following transactions. (1) The entry, if any, to record the swap on December 31, 2014. (2) The entry to record the semiannual debt interest payment on June 30, 2015. (3) The entry to record the settlement of the semiannual swap amount receivables at 8%, less amount payable at LIBOR, 7%. (4) The entry to record the change in the fair value of the debt on June 30, 2015. (5) The entry to record the change in the fair value of the swap at June 30, 2015. (b) Indicate the amount(s) reported on the balance sheet and income statement related to the debt and swap on December 31, 2014. (c) Indicate the amount(s) reported on the balance sheet and income statement related to the debt and swap on June 30, 2015. (d) Indicate the amount(s) reported on the balance sheet and income statement related to the debt and swap on December 31, 2015
Explanation / Answer
(a)
(1) No entry necessary at the date of the swap because the fair value of the swap at inception is zero.
(2) June 30
Interest Expense ..............................................400,000
Cash (8% X $10,000,000 X 1/2) ................400,000
(3)June 30
Cash...................................................................50,000
Interest Expense.......................................50,000
Interest
Received (Paid)
Swap receivable
(8% X $10,000,000 X 1/2)
$400,000
Payable at LIBOR
(7% X $10,000,000 X 1/2)
(350,000)
Cash settlement 50,000
(4)June 30
NotePayable..........................................200,000
Unrealized Holding Gain or Loss—
Income ……………………………………200,000
(5)June 30
Unrealized Holding Gain or Loss—
Income.................................................200,000
Swap Contract.................................. 200,000
(b)
Financial statement presentation as of December 31, 2002
Balance Sheet
Liabilities
Notes Payable $10,000,000
Income Statement
No effect
(c) Financial statement presentation as of June 30, 2003
Balance Sheet
Liabilities
Notes Payable $9,800,000
Swap Contract 200,000
Income Statement
Interest expense $350,000
($400,000 – $50,000)
Unrealized Holding Gain—
Note Payable $200,000
Unrealized Holding Loss—
Swap (200,000)
Total $ 0
(d) Financial statement presentation as of December 31, 2003
Balance Sheet
Assets
Swap Contract $ 60,000
Liabilities
Notes Payable 10,060,000
Income Statement
Interest expense
First six months $350,000 [as shown in (c)]
Next six months 375,000* (see below)
Total $725,000
Unrealized Holding Gain—
Swap $60,000
Unrealized Holding Loss—
Note Payable (60,000)
Total $ 0
*Swap receivable
(8% X $10,000,000 X 1/2)
$400,000
*Payable at LIBOR
(7.5% X 10,000,000 X 1/2)
375,000
Cash settlement $ 25,000
Interest expense unadjusted
June 30–December 31, 2003 $400,000
Cash settlement (25,000)
$375,000
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