P 17-16 (Fair Value Hedge Interest Rate Swap) On December 31, 2014, Mercantile C
ID: 2421101 • Letter: P
Question
P 17-16 (Fair Value Hedge Interest Rate Swap) On December 31, 2014, Mercantile Corp. had a $10,000,000 8.00% 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 8.00% 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 7.00% . 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 relationshipmeets all the conditions necessary for hedge accounting. The 6-month LIBOR rate and the swap and debt
fair values are as follows. Date 6-Month LIBOR Rate Swap Fair Value Debt Fair Value December 31, 2014 7.00% - $10,000,000 June 30, 2015 7.50% ($200,000) $9,800,000 December 31, 2015 6.00% $60,000 $10,060,000 Instructions: (a)(1) Present the journal entries to record the entry, if any, swap on December 31, 2014. Enter text answer as appropriate. (a)(2) Present the journal entries to record the semiannual debt interest payment on June 30, 2015. Jun 30, 15 Account title Amount Account title Amount (a)(3) Present the journal entries to record the settlement of the semiannual swap amount receivables at 8.00% less amount payable at LIBOR, 7.00% Jun 30, 15 Account title Amount Account title Amount Interest Received (Paid) Text title Amount Text title Amount Text title Amount (a)(4) Present the journal entries to record the change in the fair value of the debt on June 30, 2015. Jun 30, 15 Account title Amount Account title Amount (a)(5) Present the journal entries to record the change in the fair value of the swap at June 30, 2015. Jun 30, 15 Account title Amount Account title Amount (b) Indicate the amount(s) reported on the balance sheet and income statement related to the debt
and swap on December 31, 2014. Balance Sheet Liabilities Account title Amount Income Statement Amount (c) Indicate the amount(s) reported on the balance sheet and income statement related to the debt
and swap on June 30, 2015. Balance Sheet Liabilities Account title Amount Account title Amount Income Statement Account title Amount Account title Amount Account title Amount Total Formula (d) Indicate the amount(s) reported on the balance sheet and income statement related to the debt
and swap on December 31, 2015. Balance Sheet Assets Account title Amount Liabilities Account title Amount Income Statement Account title First six months Amount See (c), above. Second six months Amount See below. Account title Amount Account title Amount Total Formula Text title Amount Text title Amount Cash settlement Formula Interest expense unadjusted Text title Amount Text title Amount Formula P 17-16 (Fair Value Hedge Interest Rate Swap) On December 31, 2014, Mercantile Corp. had a $10,000,000 8.00% 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 8.00% 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 7.00% . 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. Date 6-Month LIBOR Rate Swap Fair Value Debt Fair Value December 31, 2014 7.00% - $10,000,000 June 30, 2015 7.50% ($200,000) $9,800,000 December 31, 2015 6.00% $60,000 $10,060,000 Instructions: (a)(1) Present the journal entries to record the entry, if any, swap on December 31, 2014. Enter text answer as appropriate. (a)(2) Present the journal entries to record the semiannual debt interest payment on June 30, 2015. Jun 30, 15 Account title Amount Account title Amount (a)(3) Present the journal entries to record the settlement of the semiannual swap amount receivables at 8.00% less amount payable at LIBOR, 7.00% Jun 30, 15 Account title Amount Account title Amount Interest Received (Paid) Text title Amount Text title Amount Text title Amount (a)(4) Present the journal entries to record the change in the fair value of the debt on June 30, 2015. Jun 30, 15 Account title Amount Account title Amount (a)(5) Present the journal entries to record the change in the fair value of the swap at June 30, 2015. Jun 30, 15 Account title Amount Account title Amount (b) Indicate the amount(s) reported on the balance sheet and income statement related to the debt
and swap on December 31, 2014. Balance Sheet Liabilities Account title Amount Income Statement Amount (c) Indicate the amount(s) reported on the balance sheet and income statement related to the debt
and swap on June 30, 2015. Balance Sheet Liabilities Account title Amount Account title Amount Income Statement Account title Amount Account title Amount Account title Amount Total Formula (d) Indicate the amount(s) reported on the balance sheet and income statement related to the debt
and swap on December 31, 2015. Balance Sheet Assets Account title Amount Liabilities Account title Amount Income Statement Account title First six months Amount See (c), above. Second six months Amount See below. Account title Amount Account title Amount Total Formula Text title Amount Text title Amount Cash settlement Formula Interest expense unadjusted Text title Amount Text title Amount Formula
Explanation / Answer
(a)(1) Present the journal entries to record the entry, if any, swap on December 31, 2012. No entry necessary at the date of the swap because the fair value of the swap at inception is zero. (a)(2) Present the journal entries to record the semiannual debt interest payment on June 30, 2013. Jun 30, 13 Interest Expense 400,000 Cash [$10,000,000 × 8.00% × (1/2)] 400,000 (a)(3) Present the journal entries to record the settlement of the semiannual swap amount receivables at 8.00% less amount payable at LIBOR, 7.00% Jun 30, 13 Cash 50,000 Interest Expense 50,000 Interest Received (Paid) Swap receivable [$10,000,000 × 8.00% × (1/2)] $400,000 Payable at LIBOR [$10,000,000 × 7.00% × (1/2)] $350,000 Cash settlement $50,000 (a)(4) Present the journal entries to record the change in the fair value of the debt on June 30, 2013. Jun 30, 13 Notes Payable 200,000 Unrealized Holding Gain or Loss - Income 200,000 (a)(5) Present the journal entries to record the change in the fair value of the swap at June 30, 2013. Jun 30, 11 Unrealized Holding Gain or Loss - Income 200,000 Swap Contract 200,000 (b) Indicate the amount(s) reported on the balance sheet and income statement related to the debt and swap on December 31, 2012. Balance Sheet Liabilities Notes Payable $10,000,000 Income Statement No effect (c) Indicate the amount(s) reported on the balance sheet and income statement related to the debt and swap on June 30, 2013. Balance Sheet Liabilities Notes Payable $9,800,000 Swap Contract $200,000 Income Statement Interest Expense ($400,000 - $50,000) $350,000 Unrealized Holding Gain-Notes Payable $200,000 Unrealized Holding Loss-Swap ($200,000) Total $0 (d) Indicate the amount(s) reported on the balance sheet and income statement related to the debt and swap on December 31, 2013. Balance Sheet Assets Swap Contract $60,000 Liabilities Notes Payable $10,060,000 Income Statement Interest Expense First six months $350,000 See (c), above. Second six months $375,000 See below. Unrealized Holding Gain-Swap $60,000 Unrealized Holding Loss-Notes Payable ($60,000) Total $0 Swap Receivable [8.00% × $10,000,000 × (1/2)] $400,000 Payable at LIBOR (7.50% × $10,000,000 × (1/2)] 375,000 Cash settlement $25,000 Interest expense unadjusted June 30–December 31, 2013 $400,000 Cash settlement (25,000) $375,000
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