Appendix A Derivatives
QUESTIONS FOR REVIEW OF KEY TOPICS
Question A–1
These instruments “derive” their values or contractually required cash flows from
some other security or index.
Question A–2
The FASB has taken the position that the income effects of the hedge instrument
Question A–3
If interest rates change, the change in the debt’s fair value will be less than the
change in the swap’s fair value. The gain or loss on the $500,000 notional difference
Question A–4
A futures contract is an agreement between a seller and a buyer that calls for the
seller to deliver a certain commodity (such as wheat, silver, or Treasury bond) at a
Question A–5
An interest rate swap exchanges fixed interest payments for floating rate payments,
A–2 Intermediate Accounting, 8/e
Answers to Questions (continued)
Question A–6
All derivatives, without exception, are reported on the balance sheet as either assets
Question A–7
A gain or loss from a cash flow hedge is deferred as other comprehensive income
EXERCISES
Exercise A–1
Indicate (by abbreviation) the type of hedge each activity described below would
represent.
Hedge Type
FV Fair value hedge
Activity
FV 1. An options contract to hedge possible future price changes of inventory.
CF 2. A futures contract to hedge exposure to interest rate changes prior to
A–4 Intermediate Accounting, 8/e
Exercise A–2
Requirement 1
January 1 March 31 June 30
Fair value of interest rate swap 0 $6,472 $11,394
Fair value of note payable $200,000 $206,472 $211,394
Fixed rate 10% 10% 10%
Exercise A–2 (concluded)
Requirement 2
January 1
Cash 200,000
Notes payable 200,000
March 31
Interest expense ([10% x ¼] x $200,000) 5,000
Cash 5,000
June 30
Interest expense ([10% x ¼] x $200,000) 5,000
Cash 5,000
A–6 Intermediate Accounting, 8/e
Exercise A–3
Requirement 1
January 1 March 31 June 30
Fair value of interest rate swap 0 $6,472 $11,394
Fair value of investment $200,000 $206,472 $211,394
Fixed rate 10% 10% 10%
Exercise A–3 (concluded)
Requirement 2
January 1
Investment in notes 200,000
Cash 200,000
To record the investment of the note
March 31
Cash 5,000
Interest revenue ([10% x ¼] x 200,000) 5,000
To record interest
June 30
Cash 5,000
Interest revenue ([10% x ¼] x $200,000) 5,000
To record interest
A–8 Intermediate Accounting, 8/e
Exercise A–4
Requirement 1
June 30
Fair value of interest rate swap $11,394
Fair value of note payable $220,000
Exercise A–4 (concluded)
Requirement 2
Your entries would be the same whether there was or was not an additional rise in
the fair value of the note (higher than that of the swap) on June 30 due to investors’
perceptions that the creditworthiness of LLB was improving. When a note’s fair
June 30
Interest expense ([10% x ¼] x $200,000) 5,000
Cash 5,000
To record interest
A–10 Intermediate Accounting, 8/e
Exercise A–5
January 1
Cash 200,000
Notes payable 200,000
To record the issuance of the note
March 31
Interest expense ([10% x ¼] x $200,000) 5,000
Cash 5,000
To record interest
June 30
Interest expense ([8% x ¼] x $206,472) 4,129
Notes payable (difference) 871
Cash ([10% x ¼] x $200,000) 5,000
To record interest
Exercise A–6
Requirement 1
June 30
Fair value of interest rate swap $11,394
Fair value of note payable $220,000
Fixed rate 10%
A–12 Intermediate Accounting, 8/e
Exercise A–6 (concluded)
Requirement 2
Your entries would be the same whether there was or was not an additional rise in
the fair value of the note (higher than that of the swap) on June 30 due to investors’
June 30
Interest expense ([8% x ¼] x $206,472) 4,129
Notes payable (difference) 871
Cash ([10% x ¼] x $200,000) 5,000
To record interest
PROBLEMS
Problem A–1
Requirement 1
January 1 December 31
2016 2016 2017 2018
Fixed rate 8% 8% 8% 8%
Requirement 2
January 1, 2016
Cash 100,000
Notes payable 100,000
To record the issuance of the note
December 31, 2016
Interest expense (8% x $100,000) 8,000
Cash 8,000
To record interest
A–14 Intermediate Accounting, 8/e
Problem A–1 (continued)
Requirement 3
December 31, 2017
Interest expense (8% x $100,000) 8,000
Cash 8,000
To record interest
Problem A–1 (continued)
Requirement 4
December 31, 2018
Interest expense (8% x $100,000) 8,000
Cash 8,000
To record interest
A–16 Intermediate Accounting, 8/e
Problem A–1 (continued)
Requirement 5
Swap Note
Jan. 1, 2016 100,000
Dec. 31, 2016 1,759 1,759