Question

(Fair Value Hedge) Sarazan Company issues a 4-year, 7.5% fixed-rate interest only, nonprepayable \(1,000,000

note payable on December 31, 2016. It changes the interest rate from a fixed to variable rate and enters into a swap

agreement with M&S Corp. The swap agreement specifies that Sarazan will receive a fixed rate at 7.5% and pay variable with

settlement dates that match the interest payments on the debt. Assume that interest rates have declined during 2017 and that

Sarazan received \)13,000 as an adjustment to interest expense for the settlement at December 31, 2017. The loss related to the

debt (due to interest rate changes) was \(48,000. The value of the swap contract increased \)48,000.

Instructions

(a) Prepare the journal entry to record the payment of interest expense on December 31, 2017.

(b) Prepare the journal entry to record the receipt of the swap settlement on December 31, 2017.

(c) Prepare the journal entry to record the change in the fair value of the swap contract on December 31, 2017.

(d) Prepare the journal entry to record the change in the fair value of the debt on December 31, 2017.

Short answer

1. Interest expense: $75,000
2. Interest receipt: $13,000
3. Unrealized holding gain: $48,000
4. Loss on debt securities: $48,000

Step-by-step solution

Entry for the interest expense

In this, Sarazan makes payment of interest at the rate of 7.5%

Date	Particulars	Debit	Credit
December 31, 2017	Interest Expense	$75,000
	Cash		$75,000
	(Payment of interest)

Entry of the receipt of the swap settlement contract

Date	Particulars	Debit	Credit
December 31, 2017	Cash	$13,000
	Interest Expense		$13,000

Entry for the change in the fair value of the swap contract.

Date	Particulars	Debit	Credit
December 31, 2017	Swap Contract	$48,000
	Unrealized Holding Gain or loss- Income		$48,000
	(Unrealized gain of the swap contract)

Entry for the debt

Date	Particulars	Debit	Credit
December 31, 2017	Unrealized Holding Gain or loss- loss	$48,000
	Debt		$48,000
	( loss on the debt)