Problem A–1 (continued)
Requirement 5
Swap Note
Jan. 1, 2018 100,000
Dec. 31, 2018 1,759 1,759
Problem A–1 (continued)
Requirement 6
Income Statement ( )
2018 (8,000) Interest expense
(1,000) Interest expense
2019 (8,000) Interest expense
1,000 Interest expense
2020 (8,000) Interest expense
1,000 Interest expense
Problem A–1 (concluded)
Requirement 7
Your entries would not be affected. When a note’s fair value changes by an
amount different from that of a designated hedge instrument for reasons
unrelated to interest rates, we ignore those changes. We recognize only the fair
value changes in the hedged item that we can attribute to the risk being hedged
(interest rate risk in this case). The entries still would be:
Interest expense (8% x $100,000) 8,000
Cash 8,000
To record interest
Problem A–2
Requirement 1
CMOS has an unrealized gain due to the increase in the value of the derivative
(not necessarily the same amount). Because interest rates declined, the swap
will enable CMOS to pay the lower floating rate (receive cash on the net
Requirement 2
CMOS would have an unrealized loss due to the decrease in the value of the
derivative. Because interest rates increased, the swap will cause CMOS to pay
the higher floating rate (pay cash on the net settlement of interest). The value of
Problem A-2 (continued)
Requirement 3
The unrealized gain on the swap and loss on the bonds would not be affected.
When a hedged debt’s fair value changes by an amount different from that of a
Requirement 4
There would be an unrealized gain due to the increase in the value of the
derivative. There is an unrealized loss on the bonds (a liability). However, the
gain on the derivative would be $20,000 more than the loss on the bonds.
Because the loss on the bonds is less than the gain on the swap, earnings will
Problem A–2 (concluded)
Requirement 5
There would be an unrealized loss due to a decrease in the value of the
derivative, a liability to BIOS. Because interest rates declined, the swap would
cause BIOS to receive the lower floating rate (pay cash on the net settlement of
interest). The value of the swap represents the present value of expected future
Problem A–3
Requirement 1
January 1 December 31
2018 2018 2019 2020
Fixed rate 8% 8% 8% 8%
Floating rate 8% 9% 7% 7%
Requirement 2
January 1, 2018
Cash 100,000
Notes payable
December 31, 2018
Interest expense (8% x $100,000) 8,000
Cash 8,000
Problem A–3 (continued)
Requirement 3
December 31, 2019
Interest expense (9% x $98,241) 8,842
Problem A–3 (continued)
Requirement 4
December 31, 2020
Interest expense (7% x $100,935) 7,065
Problem A–3 (continued)
Requirement 5
Swap Note
Jan. 1, 2018 100,000
Dec. 31, 2018 1,759 1,759