Reference no: EM133146080
Question - On January 1, 2021, Labtech Circuits borrowed $100,000 from First Bank by issuing a three-year, 8% note, payable on December 31, 2023. Interest is payable annually. Labtech wanted to hedge the risk that general interest rates will decline, causing the fair value of its debt to increase. Therefore, Labtech entered into a three-year interest rate swap agreement on January 1, 2021, and properly designated the swap as a hedge. The agreement called for the company to receive payment based on an 8% fixed interest rate on a notional amount of $100,000 and to pay interest based on a floating interest rate tied to SOFR. The contract called for cash settlement of the net interest amount on December 31 of each year.
Floating (SOFR) settlement rates were 8% at inception and 9%, 7%, and 7% at the end of 2021, 2022, and 2023 respectively. The fair values of the swap are quoted prices from a derivatives dealer. These quotes and the fair values of the note are as follows:
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1/1/X1
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12/31/X1
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12/31/X2
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12/31/X3
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Fair value of note payable
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$100,000
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$98,241
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$100,935
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$100,000
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Fair value of swap
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$0
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$(1,759)
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$935
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$0
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Required -
1. Calculate the net cash settlement at the end of 2021, 2022, and 2023. For each year, indicate whether the settlement is paid or received and the amount.
2. Prepare all required journal entries during 2021.
3. What would be reported on the balance sheet as of December 31, 20X1? Include in your answer the account title, amount and its balance sheet classification (asset, liability or equity).
4. What is the net effect on earnings for the year ending December 31, 20X1?
5. Prepare all required journal entries during 2022.
6. What would be reported on the balance sheet as of December 31, 20X2? Include in your answer the account title, amount and its balance sheet classification (asset, liability or equity).
7. What is the net effect on earnings for the year ending December 31, 20X2?
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