13.31
continued.
December 31, 1
13.28 (Delmar; accounting for forward commodity price contract as a
cash flow hedge.) (amounts in US$)
a. Delmar does not make an entry on October 31, 2013, because
the forward commodity contract is a mutually unexecuted
contract and requires no initial investment.
b. The fair value of the forward contract increases $100,000 [=
10,000
X
($320 –
$310)].
December 31,
2013
Forward Commodity Co
n
t
r
a
c
t ……………………………
100,000
Other Comprehensive
Income
………………………… 100,000
The forward contract is an asset because the firm has the right
to receive cash from the counterparty equal to the decline in the
fair value of the inventory; $100,000 = [10,000 X ($320 – $310)].
Solutions13-22
c. The fair value of the inventory of approximately $310 per
gallon exceeds its acquisition cost of $225 per gallon, so
Delmar would not write down its inventory.
d. March 31, 2014
Forward Commodity Co
n
t
r
a
c
t
……………………………
Other Comprehensive
Income
…………………………
400,000
400,00
0
e. March 31, 2014
Other Comprehensive
Income
…………………………….
I
n
ve
n
t
or
y ……………………………………………….
400,000
400,
00
0
f. March 31, 2014
Ca
sh
………………………………………………………..
………
Forward Commodity Co
n
t
r
a
c
t
500,000
500,
00
0
13.31
continued.
December 31, 2
$500,000 = 10,000 gallons X ($320 –
$270).
g. March 31,
2014
Ca
sh
………………………………………………………………..
2,700,000
Sales Revenue ………………………………………………
2,700,00
0
$2,700,000 = 10,000 gallons X
$270.
March 31,
2014
Accumulated Other Comprehensive Income ………..
500,000
Cost of Goods Sold (Plug)…………………………………..
1,750,000
I
n
ve
n
t
or
y ……………………………………………………… 2,250,00
0
Cost of Goods Sold (Plug) = $2,250,000 –
$500,000
=
$1,750,000
The balance in Accumulated Other Comprehensive Income
before the entry above related to the forward contract is a
credit of $500,000 (= $100,000 + $400,000). The gross
margin on the sale is $950,000 (= $2,700,000 – $1,750,000).
This is the same gross margin that Delmar would have reported
if it had not obtained the forward contract and the market
price for whiskey on March 31, 2014, had been Delmar’s
anticipated amount of $320 per gallon ($950,000 =
$3,200,000 – $2,250,000). The forward contract shifted the
risk of changes in the selling price to the counterparty.
13-23Solutions
h. Delmar would recognize changes in the fair value of both the
inventory and the forward commodity contract and include the
unrealized gains and losses in net income.
13.31
continued.
December 31, 3
i. A justification for treating the forward commodity price
contract as a fair value hedge is that the firm wanted to protect
the gross margin on the sale of $950,000 against commodity
price changes. A justification for treating the contract as a cash
flow hedge is that it wanted to ensure that it received a net
cash inflow of $3,200,000 on the sale of the whiskey.
13.29 (Owens Corporation; accounting for forward currency contract as
a fair value hedge and a cash flow hedge.) (amounts in US$)
a. July 1, 2013: The purchase commitment and the forward
foreign exchange contract are mutually unexecuted contracts as
of July 1, 2013. U.S. GAAP and IFRS do not require firms to
recognize mutually unexecuted contracts in the accounts.
December 31, 2013: The change in the value of the
undiscounted cash flows related to the purchase commitment
and the forward contract is
$1,800 [= (60,000 X $1.35) – (60,000 X $1.32)]. The present
value of
$1,800 discounted at 8% for six months is $1,731 (= $1,800 X
0.96154).
December 31, 2013
Loss on Firm Commitment……………………………….. 1,731
Commitment to Purchase Equipment…………….. 1,731
To record a loss in net income on a previously
un- recognized firm commitment because the
U.S. dol- lar decreased in value relative to the
euro.
December 31, 2013
Forward
Contract
…………………………………………….. 1,731
Gain on Forward Contract …………………………….. 1,731
To measure the forward contract at fair value
and recognize a gain in net income.
Solutions13-24
13.31
continued.
December 31, 4
Interest Expe
ns
e ………………………………………………. 69
Commitment to Purchase Equipment…………….. 69
To recognize interest on the commitment
because of the passage of time: $69 = 0.04
X $1,731.
June 30, 2014
Forward
Contract
…………………………………………….. 69
Interest Revenue…………………………………………… 69
To record interest on the forward contract
because of the passage of time: $69 = 0.04
X $1,731.
The change in the value of the purchase commitment and the
forward contract due to exchange rate changes between
December 31, 2013, and June 30, 2014, is $3,000 [= (60,000 X
$1.40) – (60,000 X $1.35)].
June 30, 2014
Loss on Firm Commitment……………………………….. 3,000
Commitment to Purchase Equipment…………….. 3,000
To record a loss on the purchase commitment
be- cause the value of the U.S. dollar declined
relative to the euro.
June 30, 2014
Forward
Contract
…………………………………………….. 3,000
Gain on Forward Contract …………………………….. 3,000
To record the increase in the fair value of
the for- ward contract because the U.S.
dollar declined in value relative to the euro.
June 30, 2014
Equipment
………………………………………………………. 79,200
Commitment to Purchase Equipment…………………4,800
Ca
sh
……………………………………………………………. 84,000
To record the amount paid in U.S. d
oll
a
rs
[$84
,
000 = ($60,000 X $1.4)], to eliminate
the bal- ance in the Commitment to Purchase
Equipment account of $4,800 (= $1,731 +
$69 + $3,000), and to record the acquisition
cost of the equipment for
$79,200.
13.31
continued.
December 31, 5
13-25Solutions
Ca
sh
……………………………………………………………….. 4,800
Forward
Contract
…………………………………………. 4,800
To record cash received from the
counterparty and eliminate the balance in
the Forward Contract account of $4,800 (=
$1,731 + $69 + $3,000).
b. Owens Corporation would not recognize changes in the value of
the purchase commitment. The entries for changes in the fair
value of the forward contract would afect other comprehensive
income each period instead of net income. On June 30, 2014,
Accumulated Other Comprehensive Income would have a
balance of $4,800 (= $1,731 + $69
+ $3,000). The entry on this date to purchase the
equipment would
involve a debit to Accumulated Other Comprehensive Income
instead of the Commitment to Purchase Equipment account as
shown in Part a. above.
c. To treat this hedge as a fair value hedge, Owens Corporation
must intend to protect the value of the equipment. Perhaps
Owens Corporation has committed to resell the equipment to a
customer on June 30, 2014, for a fixed price in U.S. dollars and
wants to protect its expected profit margin from the sale. To
treat this hedge as a cash flow hedge, Owens Corporation must
intend to protect the amount of cash it pays to the European
supplier.
13.30 (Sandretto Corporation; accounting for interest rate swap as a fair
value hedge.) (amounts in US$)
a. January 1, 2013
Equipment
………………………………………………………. 50,000
Note Payable ……………………………………………….. 50,000
To record the acquisition of equipment by giving a
$50,000 note payable with a fixed interest rate of
6%.
December 31, 2013
Interest Expe
ns
e ……………………………………………….3,000
Ca
sh
……………………………………………………………. 3,000
13.31
continued.
December 31, 6
To recognize interest expense and cash
payment at the fixed interest rate of 6%:
$3,000 = 0.06
X
$50,000.
Solutions13-26
Interest rates increased during 2013. On December 31, the
counterparty with whom Sandretto Corporation entered into the
swap contract resets the interest rate for 2013 to 8%.
Sandretto Corporation must restate the note payable to fair
value and record the change in the fair value of the swap
contract caused by the increase in the interest rate. The
present value of the remaining cash flows on the note payable
when discounted at 8% is:
Present Value of Interest Payments: $3,000 X 1.7832
6
= …
$ 5,
35
0
Present Value of Principal: $50,000 X 0.85734
=……………..
4
2
, 86
7
Total Present Value
………………………………………………..
$
4
8
, 21
7
Sandretto Corporation makes the following entry to record the
change in fair value:
December 31,
2013
Note Payable ……………………………………………………
1,783
Gain on Revaluation of Note Payable……………… 1,783
To measure the note payable at fair value
with cash flows discounted at 8%: $1,783 =
$50,000 –
$48,217. The gain is included in net
income.
The increase in interest rate to 8% means that Sandretto
Corporation must pay an additional $1,000 [= (0.08 – 0.06) X
$50,000] each year in interest payments. The present value of
a $1,000 annuity for two periods at 8% is $1,783 (= $1,000 X
1.78326). Thus, the fair value of the swap contract increased
from zero at the beginning of 2013 to
$1,783 at the end of 2013. Sandretto Corporation makes the
following entry:
13.31
continued.
December 31, 7
December 31,
2013
Loss on Revaluation of Swap Contract ……………….
1,783
Swap C
on
t
r
a
c
t ……………………………………………… 1,783
To measure the swap contract at fair value
and recognize a liability on the balance
sheet and a loss in net income.
13-27Solutions
Interest Expe
ns
e ……………………………………………….3,857
Note Payable ……………………………………………….. 857
Ca
sh
……………………………………………………………. 3,000
To record interest expense at 8% of the
carrying value of the note payable at the
beginning of the year ($3,857 = 0.08 X
$48,217), the cash payment at the
contractual interest rate of 6% on the face
amount of the note ($3,000 = 0.06 X
$50,000), and the increase in the carrying
value of the note pay- able for the diference.
December 31, 2014
Interest Expe
ns
e ……………………………………………….143
Swap C
on
t
r
a
c
t ……………………………………………… 143
To record interest expense for the increase in
the carrying value of the swap contract for the
passage of time: $143 = 0.08 X $1,783.
December 31, 2014
Swap C
on
t
r
a
c
t …………………………………………………. 1,000
Ca
sh
……………………………………………………………. 1,000
To record cash paid to the counterparty
because the interest rate increased from
6% to 8%.
Sandretto must revalue the note payable and the swap
contract for changes in fair value. The bank resets the interest
rate in the swap agreement to 4% for 2015. The present value
of the remaining payments on the note at 4% is:
Present Value of Interest Payments: $3,000 X 0.9615
4
= …
$ 2,
88
5
Present Value of Principal: $50,000 X 0.96154
=……………..
4
8
, 07
7
Total Present Va
lu
e
…………………………………………………..
$
5
0
, 96
2
13.31
continued.
December 31, 8
The carrying value of the note payable before revaluation is
$49,074 (= $48,217 + $857). The entry to measure the note
payable at fair value is:
Solutions13-28
Loss on Revaluation of Note
P
ayab
l
e …………………. 1,888
Note Payable ……………………………………………….. 1,888
To measure the note payable at fair value
using an interest rate of 4% to discount the
remaining cash flows to a present value:
$1,888 = $50,962 –
$49,074. The loss is included in net income.
The fair value of the swap contract increases. Sandretto
Corporation will receive $1,000 at the end of 2015 because of
the swap contract. Thus, the swap contract becomes an asset
instead of a liability. The present value of $1,000 when
discounted at 4% is $962 (= $1,000
X
0.96154). The carrying value of the swap contract before
revaluation is
a liability of $926 (= $1,783 + $143 – $1,000). The entry to
revalue the swap contract is:
December 31, 2014
Swap Contract (
Li
ab
ili
ty) …………………………………. 926
Swap Contract
(Asset)
……………………………………… 962
Gain on Revaluation of Swap Contract …………… 1,888
To measure the swap contract at fair value
using a discount rate of 4% and recognize a
gain in net income from the increase in fair
value.
At the end of 2014, the Note Payable account has a balance of
$50,962 and the Swap Contract account has a debit balance of
$962.
b. January 1, 2015
Note Payable …………………………………………………… 50,962
Ca
sh
……………………………………………………………. 50
,
000
13.31
continued.
December 31, 9
Swap Contract
(Asset)
………………………………….. 962
To repay note payable prior to maturity and
close out the swap contract.
c. The entries would be identical if Sandretto Corporation chose
the fair value option because the note payable and swap
contract would be measured at fair value and changes in fair
value included in net income under both the accounting for the
derivative as a fair value hedge and the accounting under the
fair value option.
13-29Solutions
13.31 (Avery Corporation; accounting for an interest rate swap as a
cash flow hedge.) (amounts in US$)
January 1,
2013
Eq
ui
pm
en
t ……………………………………………………………
50,000
Note Payable…………………………………………………… 50,000
To record the acquisition of equipment by
giving a
$50,000 note payable with a variable interest
rate of
6%
.
December 31,
2013
Interest Expense……………………………………………………
3,000
Cash ………………………………………………………………. 3,000
To recognize interest expense and cash
payment at the variable interest rate of 6%:
$3,000 = 0.06
X
$50,00
0.
The fair value of the swap agreement on December 31, 2013, after
the counterparty resets the interest rate to 8% is $1,783 (= $1,000
X 1.78326). This amount is the present value of the $1,000 that the
13.31
continued.
December 31, 10
counterparty will pay Avery Corporation on December 31 of 2014
and December 31 of 2015 if the interest rate remains at 8%.
December 31,
2013
Swap Contract………………………………………………………
1,783
Gain on Revaluation of Swap Contract………………. 1,783
To measure the swap contract at fair value and
recog- nize an asset on the balance sheet and a
gain in other comprehensive income.
December 31,
2014
Interest Expense……………………………………………………
4,000
Cash ………………………………………………………………. 4,000
To recognize interest expense and cash
payment at the variable interest rate: $4,000
= 0.08 X $50,000.
Avery Corporation must also recognize interest on the swap
contract because of the passage of time.
Solutions13-30
Swap Contract……………………………………………………… 143
Interest on Swap Contract ……………………………….. 143
To record interest for the increase in the
carrying value of the swap contract for the
passage of time:
$143 = 0.08 X $1,783.
Avery Corporation receives from the counterparty the $1,000 [=
$50,000
X
(0.08 – 0.06)] required by the swap contract. The entry is:
December 31, 2014
Cash……………………………………………………………………. 1,000
Swap Contract ………………………………………………… 1,000
To record cash received from the counterparty
because the interest rate increased from 6% to
8%.
13.31
continued.
December 31, 11
December 31, 2014
Accumulated Other Comprehensive Income ……………. 1,000
Interest Expense ……………………………………………… 1,000
To reclassify a portion of accumulated other
compre- hensive income to net income for the
hedged portion of interest expense on the note
payable.
At this point the swap contract account has a debit balance of
$926 (= $1,783 + $143 – $1,000). Accumulated other
comprehensive income related to this transaction has a credit
balance of $926.
Resetting the interest rate on December 31, 2014, to 4%
changes the
fair value of the swap contract from an asset to a liability. The
present value of the $1,000 that Avery Corporation will pay to the
counterparty at the end of 2015 when discounted at 4% is $962 (=
$1,000 X 0.96154). The entry to revalue the swap contract is:
December 31, 2014
Loss on Revaluation of Swap Contract …………………… 1,888
Swap Contract (Asset) …………………………………….. 926
Swap Contract (Liability) ………………………………… 962
To measure the swap contract at fair value and
recog- nize a liability on the balance sheet and a
loss
in
ot
h
e
r
comprehensive income.
13-31Solutions
Interest Expense…………………………………………………… 2,000
Cash ………………………………………………………………. 2,000
To recognize interest expense and cash
payment at the variable interest rate of 4%:
$2,000 = 0.04
X
$50,000.
December 31, 2015
Interest on Swap C
on
t
r
a
c
t …………………………………….. 38
Swap Contract ………………………………………………… 38
To record interest for the increase in the
carrying value of the swap contract for the
passage of time:
$38 = 0.04 X $962.
December 31, 2015
13.31
continued.
December 31, 12
Swap Contract……………………………………………………… 1,000
Cash ………………………………………………………………. 1,000
To record cash paid to the counterparty
because the interest rate decreased from 8%
to 4%.
December 31, 2015
Interest Expense…………………………………………………… 1,000
Accumulated Other Comprehensive I
nc
ome ……….. 1,000
To reclassify a portion of accumulated other
compre- hensive income to net income for the
hedged portion of interest expense on the note
payable.
December 31, 2015
Note
Payable
……………………………………………………….. 50,000
Cash ………………………………………………………………. 50,000
To record repayment of note payable at maturity.
The Swap Contract account has a balance of zero on December
31, 2015 (= $962 + $38 – $1,000). Thus, Avery Corporation makes
no entry to close out the Swap Contract account.
Solutions13-32
13.31
continued.
December 31, 2
$500,000 = 10,000 gallons X ($320 –
$270).
g. March 31,
2014
Ca
sh
………………………………………………………………..
2,700,000
Sales Revenue ………………………………………………
2,700,00
0
$2,700,000 = 10,000 gallons X
$270.
March 31,
2014
Accumulated Other Comprehensive Income ………..
500,000
Cost of Goods Sold (Plug)…………………………………..
1,750,000
I
n
ve
n
t
or
y ……………………………………………………… 2,250,00
0
Cost of Goods Sold (Plug) = $2,250,000 –
$500,000
=
$1,750,000
The balance in Accumulated Other Comprehensive Income
before the entry above related to the forward contract is a
credit of $500,000 (= $100,000 + $400,000). The gross
margin on the sale is $950,000 (= $2,700,000 – $1,750,000).
This is the same gross margin that Delmar would have reported
if it had not obtained the forward contract and the market
price for whiskey on March 31, 2014, had been Delmar’s
anticipated amount of $320 per gallon ($950,000 =
$3,200,000 – $2,250,000). The forward contract shifted the
risk of changes in the selling price to the counterparty.
13-23Solutions
h. Delmar would recognize changes in the fair value of both the
inventory and the forward commodity contract and include the
unrealized gains and losses in net income.
13.31
continued.
December 31, 3
i. A justification for treating the forward commodity price
contract as a fair value hedge is that the firm wanted to protect
the gross margin on the sale of $950,000 against commodity
price changes. A justification for treating the contract as a cash
flow hedge is that it wanted to ensure that it received a net
cash inflow of $3,200,000 on the sale of the whiskey.
13.29 (Owens Corporation; accounting for forward currency contract as
a fair value hedge and a cash flow hedge.) (amounts in US$)
a. July 1, 2013: The purchase commitment and the forward
foreign exchange contract are mutually unexecuted contracts as
of July 1, 2013. U.S. GAAP and IFRS do not require firms to
recognize mutually unexecuted contracts in the accounts.
December 31, 2013: The change in the value of the
undiscounted cash flows related to the purchase commitment
and the forward contract is
$1,800 [= (60,000 X $1.35) – (60,000 X $1.32)]. The present
value of
$1,800 discounted at 8% for six months is $1,731 (= $1,800 X
0.96154).
December 31, 2013
Loss on Firm Commitment……………………………….. 1,731
Commitment to Purchase Equipment…………….. 1,731
To record a loss in net income on a previously
un- recognized firm commitment because the
U.S. dol- lar decreased in value relative to the
euro.
December 31, 2013
Forward
Contract
…………………………………………….. 1,731
Gain on Forward Contract …………………………….. 1,731
To measure the forward contract at fair value
and recognize a gain in net income.
Solutions13-24
13.31
continued.
December 31, 4
Interest Expe
ns
e ………………………………………………. 69
Commitment to Purchase Equipment…………….. 69
To recognize interest on the commitment
because of the passage of time: $69 = 0.04
X $1,731.
June 30, 2014
Forward
Contract
…………………………………………….. 69
Interest Revenue…………………………………………… 69
To record interest on the forward contract
because of the passage of time: $69 = 0.04
X $1,731.
The change in the value of the purchase commitment and the
forward contract due to exchange rate changes between
December 31, 2013, and June 30, 2014, is $3,000 [= (60,000 X
$1.40) – (60,000 X $1.35)].
June 30, 2014
Loss on Firm Commitment……………………………….. 3,000
Commitment to Purchase Equipment…………….. 3,000
To record a loss on the purchase commitment
be- cause the value of the U.S. dollar declined
relative to the euro.
June 30, 2014
Forward
Contract
…………………………………………….. 3,000
Gain on Forward Contract …………………………….. 3,000
To record the increase in the fair value of
the for- ward contract because the U.S.
dollar declined in value relative to the euro.
June 30, 2014
Equipment
………………………………………………………. 79,200
Commitment to Purchase Equipment…………………4,800
Ca
sh
……………………………………………………………. 84,000
To record the amount paid in U.S. d
oll
a
rs
[$84
,
000 = ($60,000 X $1.4)], to eliminate
the bal- ance in the Commitment to Purchase
Equipment account of $4,800 (= $1,731 +
$69 + $3,000), and to record the acquisition
cost of the equipment for
$79,200.
13.31
continued.
December 31, 5
13-25Solutions
Ca
sh
……………………………………………………………….. 4,800
Forward
Contract
…………………………………………. 4,800
To record cash received from the
counterparty and eliminate the balance in
the Forward Contract account of $4,800 (=
$1,731 + $69 + $3,000).
b. Owens Corporation would not recognize changes in the value of
the purchase commitment. The entries for changes in the fair
value of the forward contract would afect other comprehensive
income each period instead of net income. On June 30, 2014,
Accumulated Other Comprehensive Income would have a
balance of $4,800 (= $1,731 + $69
+ $3,000). The entry on this date to purchase the
equipment would
involve a debit to Accumulated Other Comprehensive Income
instead of the Commitment to Purchase Equipment account as
shown in Part a. above.
c. To treat this hedge as a fair value hedge, Owens Corporation
must intend to protect the value of the equipment. Perhaps
Owens Corporation has committed to resell the equipment to a
customer on June 30, 2014, for a fixed price in U.S. dollars and
wants to protect its expected profit margin from the sale. To
treat this hedge as a cash flow hedge, Owens Corporation must
intend to protect the amount of cash it pays to the European
supplier.
13.30 (Sandretto Corporation; accounting for interest rate swap as a fair
value hedge.) (amounts in US$)
a. January 1, 2013
Equipment
………………………………………………………. 50,000
Note Payable ……………………………………………….. 50,000
To record the acquisition of equipment by giving a
$50,000 note payable with a fixed interest rate of
6%.
December 31, 2013
Interest Expe
ns
e ……………………………………………….3,000
Ca
sh
……………………………………………………………. 3,000
13.31
continued.
December 31, 6
To recognize interest expense and cash
payment at the fixed interest rate of 6%:
$3,000 = 0.06
X
$50,000.
Solutions13-26
Interest rates increased during 2013. On December 31, the
counterparty with whom Sandretto Corporation entered into the
swap contract resets the interest rate for 2013 to 8%.
Sandretto Corporation must restate the note payable to fair
value and record the change in the fair value of the swap
contract caused by the increase in the interest rate. The
present value of the remaining cash flows on the note payable
when discounted at 8% is:
Present Value of Interest Payments: $3,000 X 1.7832
6
= …
$ 5,
35
0
Present Value of Principal: $50,000 X 0.85734
=……………..
4
2
, 86
7
Total Present Value
………………………………………………..
$
4
8
, 21
7
Sandretto Corporation makes the following entry to record the
change in fair value:
December 31,
2013
Note Payable ……………………………………………………
1,783
Gain on Revaluation of Note Payable……………… 1,783
To measure the note payable at fair value
with cash flows discounted at 8%: $1,783 =
$50,000 –
$48,217. The gain is included in net
income.
The increase in interest rate to 8% means that Sandretto
Corporation must pay an additional $1,000 [= (0.08 – 0.06) X
$50,000] each year in interest payments. The present value of
a $1,000 annuity for two periods at 8% is $1,783 (= $1,000 X
1.78326). Thus, the fair value of the swap contract increased
from zero at the beginning of 2013 to
$1,783 at the end of 2013. Sandretto Corporation makes the
following entry:
13.31
continued.
December 31, 7
December 31,
2013
Loss on Revaluation of Swap Contract ……………….
1,783
Swap C
on
t
r
a
c
t ……………………………………………… 1,783
To measure the swap contract at fair value
and recognize a liability on the balance
sheet and a loss in net income.
13-27Solutions
Interest Expe
ns
e ……………………………………………….3,857
Note Payable ……………………………………………….. 857
Ca
sh
……………………………………………………………. 3,000
To record interest expense at 8% of the
carrying value of the note payable at the
beginning of the year ($3,857 = 0.08 X
$48,217), the cash payment at the
contractual interest rate of 6% on the face
amount of the note ($3,000 = 0.06 X
$50,000), and the increase in the carrying
value of the note pay- able for the diference.
December 31, 2014
Interest Expe
ns
e ……………………………………………….143
Swap C
on
t
r
a
c
t ……………………………………………… 143
To record interest expense for the increase in
the carrying value of the swap contract for the
passage of time: $143 = 0.08 X $1,783.
December 31, 2014
Swap C
on
t
r
a
c
t …………………………………………………. 1,000
Ca
sh
……………………………………………………………. 1,000
To record cash paid to the counterparty
because the interest rate increased from
6% to 8%.
Sandretto must revalue the note payable and the swap
contract for changes in fair value. The bank resets the interest
rate in the swap agreement to 4% for 2015. The present value
of the remaining payments on the note at 4% is:
Present Value of Interest Payments: $3,000 X 0.9615
4
= …
$ 2,
88
5
Present Value of Principal: $50,000 X 0.96154
=……………..
4
8
, 07
7
Total Present Va
lu
e
…………………………………………………..
$
5
0
, 96
2
13.31
continued.
December 31, 8
The carrying value of the note payable before revaluation is
$49,074 (= $48,217 + $857). The entry to measure the note
payable at fair value is:
Solutions13-28
Loss on Revaluation of Note
P
ayab
l
e …………………. 1,888
Note Payable ……………………………………………….. 1,888
To measure the note payable at fair value
using an interest rate of 4% to discount the
remaining cash flows to a present value:
$1,888 = $50,962 –
$49,074. The loss is included in net income.
The fair value of the swap contract increases. Sandretto
Corporation will receive $1,000 at the end of 2015 because of
the swap contract. Thus, the swap contract becomes an asset
instead of a liability. The present value of $1,000 when
discounted at 4% is $962 (= $1,000
X
0.96154). The carrying value of the swap contract before
revaluation is
a liability of $926 (= $1,783 + $143 – $1,000). The entry to
revalue the swap contract is:
December 31, 2014
Swap Contract (
Li
ab
ili
ty) …………………………………. 926
Swap Contract
(Asset)
……………………………………… 962
Gain on Revaluation of Swap Contract …………… 1,888
To measure the swap contract at fair value
using a discount rate of 4% and recognize a
gain in net income from the increase in fair
value.
At the end of 2014, the Note Payable account has a balance of
$50,962 and the Swap Contract account has a debit balance of
$962.
b. January 1, 2015
Note Payable …………………………………………………… 50,962
Ca
sh
……………………………………………………………. 50
,
000
13.31
continued.
December 31, 9
Swap Contract
(Asset)
………………………………….. 962
To repay note payable prior to maturity and
close out the swap contract.
c. The entries would be identical if Sandretto Corporation chose
the fair value option because the note payable and swap
contract would be measured at fair value and changes in fair
value included in net income under both the accounting for the
derivative as a fair value hedge and the accounting under the
fair value option.
13-29Solutions
13.31 (Avery Corporation; accounting for an interest rate swap as a
cash flow hedge.) (amounts in US$)
January 1,
2013
Eq
ui
pm
en
t ……………………………………………………………
50,000
Note Payable…………………………………………………… 50,000
To record the acquisition of equipment by
giving a
$50,000 note payable with a variable interest
rate of
6%
.
December 31,
2013
Interest Expense……………………………………………………
3,000
Cash ………………………………………………………………. 3,000
To recognize interest expense and cash
payment at the variable interest rate of 6%:
$3,000 = 0.06
X
$50,00
0.
The fair value of the swap agreement on December 31, 2013, after
the counterparty resets the interest rate to 8% is $1,783 (= $1,000
X 1.78326). This amount is the present value of the $1,000 that the
13.31
continued.
December 31, 10
counterparty will pay Avery Corporation on December 31 of 2014
and December 31 of 2015 if the interest rate remains at 8%.
December 31,
2013
Swap Contract………………………………………………………
1,783
Gain on Revaluation of Swap Contract………………. 1,783
To measure the swap contract at fair value and
recog- nize an asset on the balance sheet and a
gain in other comprehensive income.
December 31,
2014
Interest Expense……………………………………………………
4,000
Cash ………………………………………………………………. 4,000
To recognize interest expense and cash
payment at the variable interest rate: $4,000
= 0.08 X $50,000.
Avery Corporation must also recognize interest on the swap
contract because of the passage of time.
Solutions13-30
Swap Contract……………………………………………………… 143
Interest on Swap Contract ……………………………….. 143
To record interest for the increase in the
carrying value of the swap contract for the
passage of time:
$143 = 0.08 X $1,783.
Avery Corporation receives from the counterparty the $1,000 [=
$50,000
X
(0.08 – 0.06)] required by the swap contract. The entry is:
December 31, 2014
Cash……………………………………………………………………. 1,000
Swap Contract ………………………………………………… 1,000
To record cash received from the counterparty
because the interest rate increased from 6% to
8%.
13.31
continued.
December 31, 11
December 31, 2014
Accumulated Other Comprehensive Income ……………. 1,000
Interest Expense ……………………………………………… 1,000
To reclassify a portion of accumulated other
compre- hensive income to net income for the
hedged portion of interest expense on the note
payable.
At this point the swap contract account has a debit balance of
$926 (= $1,783 + $143 – $1,000). Accumulated other
comprehensive income related to this transaction has a credit
balance of $926.
Resetting the interest rate on December 31, 2014, to 4%
changes the
fair value of the swap contract from an asset to a liability. The
present value of the $1,000 that Avery Corporation will pay to the
counterparty at the end of 2015 when discounted at 4% is $962 (=
$1,000 X 0.96154). The entry to revalue the swap contract is:
December 31, 2014
Loss on Revaluation of Swap Contract …………………… 1,888
Swap Contract (Asset) …………………………………….. 926
Swap Contract (Liability) ………………………………… 962
To measure the swap contract at fair value and
recog- nize a liability on the balance sheet and a
loss
in
ot
h
e
r
comprehensive income.
13-31Solutions
Interest Expense…………………………………………………… 2,000
Cash ………………………………………………………………. 2,000
To recognize interest expense and cash
payment at the variable interest rate of 4%:
$2,000 = 0.04
X
$50,000.
December 31, 2015
Interest on Swap C
on
t
r
a
c
t …………………………………….. 38
Swap Contract ………………………………………………… 38
To record interest for the increase in the
carrying value of the swap contract for the
passage of time:
$38 = 0.04 X $962.
December 31, 2015
13.31
continued.
December 31, 12
Swap Contract……………………………………………………… 1,000
Cash ………………………………………………………………. 1,000
To record cash paid to the counterparty
because the interest rate decreased from 8%
to 4%.
December 31, 2015
Interest Expense…………………………………………………… 1,000
Accumulated Other Comprehensive I
nc
ome ……….. 1,000
To reclassify a portion of accumulated other
compre- hensive income to net income for the
hedged portion of interest expense on the note
payable.
December 31, 2015
Note
Payable
……………………………………………………….. 50,000
Cash ………………………………………………………………. 50,000
To record repayment of note payable at maturity.
The Swap Contract account has a balance of zero on December
31, 2015 (= $962 + $38 – $1,000). Thus, Avery Corporation makes
no entry to close out the Swap Contract account.
Solutions13-32