Deck 22: Derivatives and Related Accounting Issues

Question 1

Which of the following statements is true?

A)​The ability to settle the derivative by actually buying or selling the related asset is referred to as net settlement.
B)​The quantity or number of units specified by a derivative is known as the underlying.
C)​A derivative instrument derives its value from a related asset or liability.
D)​Usually, a derivative instrument requires little or no initial investment.

Answer 1

D

Question 2

A critical characteristic of a derivative is that the instrument

A)​derives its value from a related asset or liability.
B)​derives its value from changes in value of a related asset or liability.
C)​requires that the related asset or liability be sold or bought at settlement.
D)​requires the holder of the derivative instrument to make a significant investment.

Answer 2

B

Question 3

If the change in the value of the derivative (gain or loss) exceeds the change in the value of the forecasted transaction, the excess is considered the ineffective portion of the derivative and is recognized in OCI.

Answer 3

False

Question 4

The gains and losses from cash flow hedges are recorded in OCI until the impact of the hedged item in included in earnings.

Question 5

The underlying amount of a derivative instrument is

A)​related to the number of units specified in the derivative and the price that relates to the asset or liability underlying the derivative.
B)​the change in the price or rate that relates to the asset or liability underlying the derivative.
C)​the price or rate that relates to the asset or liability underlying the derivative.
D)​the number of units that is specified in the derivative instrument.

Question 6

The FASB requires entities that hold or issue derivative instruments that are designated and qualify as hedging instruments to disclose information that allows users to understand how and why the reporting entity uses derivative instruments.

Question 7

The total value of a derivative is determined by the

A)​number of units specified in the derivative and the price that relates to the asset or liability underlying the derivative.
B)​change in the price or rate that relates to the asset or liability underlying the derivative.
C)​price or rate that relates to the asset or liability underlying the derivative.
D)​number of units that is specified in the derivative instrument.

Question 8

The FASB requires entities that hold or issue derivative instruments that are designated and qualify as hedging instruments to disclose information that allows users to understand in the case of both fair value and cash flow hedges, how the derivative instruments and the related hedged items affect the reporting entity's financial position, financial performance and cash flows.

Question 9

The gains and losses from cash flow hedges are included in OCI; however, if the hedge is ineffective, the gains and losses are included in current earnings.

Question 10

On September 1st of the current year, Mooney Company writes a contract agreeing to sell to Berry Company 200,000 foreign currency (FC) units at a specific price of $2.14 per FC with delivery in 30 days.The spot rate at the end of 30 days is $2.17.The appropriate discount rate for both Mooney Company and Berry Company is 9%, and Mooney's year end is December 31. ​
On the settlement of the contract, Mooney would record a

A)​gain of $6,000.
B)​gain of $5,955.
C)​loss of $6,000.
D)​loss of $5,955.

Question 11

A hedge of a forecasted transaction is a cash flow hedge.

Question 12

A forward contract

A)​is not traded on an organized exchange and is customized to meet the needs of the parties.
B)​is not traded on an organized exchange and is subject to formal regulation which results in standardized contracts.
C)​is traded on an organized exchange and is subject to formal regulation which results in standardized contracts.
D)​is traded on an organized exchange and is customized to meet the needs of the parties.

Question 13

On August 1st of the current year, Lenz Company writes a contract agreeing to sell to Hindman Company 15,000 British pounds at a specific price of $0.69 per pound with delivery in 60 days.Throughout the 60-day period the forward rate varies as follows: ?

$\begin{array}{ll}60 \text { days remaining on the contract } & \$ 0.69 \\30 \text { days remaining on the contract } & \$ 0.68 \\0 \text { days remaining on the contract } & \$ 0.675\end{array}$
Assume an 8% discount rate for Lenz Company and Hindman Company.For the first 30 day period, Lenz Company would recognize a:

A)$149 loss.
B)$149 gain.
C)$150 loss.
D)$150 gain.

Question 14

The FASB requires entities that hold or issue derivative instruments that are designated and qualify as hedging instruments to disclose information that allows users to understand in the case of both fair value and cash flow hedges, how the derivative instruments and the related hedged items are accounted for.

Question 15

If a trading portfolio consisted of debt instruments, such investments would be marked-to-market, and both increases and decreases in value would be recognized in current earnings.

Question 16

The gains and losses from fair value hedges are reported in earnings.

Question 17

The notional amount of a derivative instrument is

A)​related to the number of units specified in the derivative and the price that relates to the asset or liability underlying the derivative.
B)​the change in the price or rate that relates to the asset or liability underlying the derivative.
C)​the price or rate that relates to the asset or liability underlying the derivative.
D)​the number of units that is specified in the derivative instrument.

Question 18

If both increases and decreases in the value of a recognized asset or liability are recognized in current earnings according to existing accounting principles, special hedge accounting is necessary.

Question 19

Forward contracts are contracts to buy or sell a specified amount of an asset at a specified, fixed price with delivery at a specified future point in time.Which of the following is true about these contracts?

A)​The party that agrees to buy the asset is said to be in a short position.
B)​The party that agrees to sell the asset is said to be in a long position.
C)​The specified, fixed price in the contract is known as the forward rate.
D)​A forward contract requires an initial deposit of funds with the transacting broker.

Question 20

On August 1st of the current year, Lenz Company writes a contract agreeing to sell to Hindman Company 15,000 British pounds at a specific price of $0.69 per pound with delivery in 60 days.Throughout the 60-day period the forward rate varies as follows: ?

$\begin{array}{ll}60 \text { days remaining on the contract } & \$ 0.69 \\30 \text { days remaining on the contract } & \$ 0.68 \\0 \text { days remaining on the contract } & \$ 0.675\end{array}$ The spot rate at the end of 60 days is $0.675.Assume an 8% discount rate for both Lenz Company and Hindman Company.For the second thirty day period, Hindman would recognize a:

A)-$225 loss.
B)-$225 gain.
C)-$76 loss.
D)-$76 gain

Question 21

Which of the following is true about options?

A)​Generally, higher volatility of the underlying increases the value of the option.
B)​The value of an option is realized only through its being exercised.
C)​An American option is exercisable at its maturity date.
D)​An option premium is refundable if the option becomes unfavorable.

Question 22

On August 1, an oil producer decided to hedge the fair value of its inventory by acquiring a futures contract to sell 100,000 barrels of oil on November 1 for $85.00 each.Price data follow: ?
$$\begin{array} { l r r } & \text { Spot Frice } & \text { Futures Price } \\\text { August 1 } & \$ 84.00 & \$ 85.00 \\\text { September 1 } & 82.80 & 83.50 \\\text { October 1 } & 82.20 & 82.40 \\\text { November 1 } & 81.00 & 81.00\end{array}$$ What was the fair value of the contract on October 1?

A)-$280,000
B)-$110,000
C)-$260,000
D)-$20,000

Question 23

Clark Company holds several options: ?
$\begin{array}{lrr}& \text { Spot Price } & \text { Strike Price } \\\text { Call option on Ionics } & \$ 29.80 & \$ 27.90 \\\text { Call option on Kimberly } & 60.41 & 64.84 \\\text { Put option on Motorola } & 14.25 & 16.40 \\\text { Put option on Nortek } & 32.10 & 32.10\end{array}$
The intrinsic value of Clark Company's options is

A)-$0.38.
B)-$4.05.
C)-$4.43.
D)-$8.48.

Question 24

A futures contract

A)​is not traded on an organized exchange and is customized to meet the needs of the parties.
B)​is not traded on an organized exchange and is subject to formal regulations which results in standardized contrasts.
C)​is traded on an organized exchange and is subject to formal regulations which results in standardized contrasts.
D)​is traded on an organized exchange and is customized to meet the needs of the parties.

Question 25

An advantage of a fair value hedge is that:

A)​gains or losses on the derivative hedging instrument and the offsetting gains or losses on the hedged items are both recognized currently in earnings.
B)​gains or losses on hedges of firm commitments are reported in other comprehensive income because the anticipated cash flows have not been recognized in earnings.
C)​documentation is not necessary for fair value hedges.
D)​a bank may use a fair value hedge to hedge the risk that a customer's loan will be prepaid.

Question 26

A fair value hedge may be used for all of the following except:

A)​a purchase order.
B)​inventory of corn.
C)​long-term debt.
D)​anticipated sales of aluminum.

Question 27

A hedge to avoid the potential unfavorable effects of changing prices associated with all of the following would qualify for special fair value hedge accounting except:

A)debt instruments held in a trading portfolio.
B)​equity and debt instruments held in an available-for-sale portfolio.
C)​a firm commitment to acquire crude oil.
D)​a farmer's inventory of hogs.

Question 28

An option

A)​is not traded on an organized exchange and is customized to meet the needs of the parties.
B)​is not traded on an organized exchange and is subject to formal regulations which results in standardized contracts
C)​is traded on an organized exchange or may be negotiated on a case-by-case basis between counterparties.
D)​is traded on an organized exchange and is customized to meet the needs of the parties.

Question 29

Based on the relationship between the strike price and the current price, an option may be at-the-money, out-of-the-money or in-the-money.Which of the following statements is true?

A)​A Call Option is out-of-the-money when the strike price is greater than the current price.
B)​A Put Option is in-the-money when the strike price is greater than the current price.
C)​A Put Option is out-of-the-money when the strike price is less than the current price.
D)​All of the above are true.

Question 30

Both forward contracts and futures contracts provide for the receipt or payment of a specific amount of an asset at a specific price with delivery at a specified future point in time.Which combination of characteristics is true for a futures contract? ?
$\begin{array}{cc} \text { Subject to } & \text { Subject to } \\ \text { margin call } & \text { discounting } \\\end{array}$

A) $\begin{array}{ll}&\text { No } &&&& \text { No } \\\end{array}$
B) $\begin{array}{ll}&\text { No } &&&& \text { Yes } \\\end{array}$
C) $\begin{array}{ll}&\text { Yes } &&&& \text { No } \\\end{array}$
D) $\begin{array}{ll}&\text {Yes } &&&& \text { Yes }\end{array}$

Question 31

The difference between the strike price of an option and spot price of the item being hedge at any one time represents the option's:

A)​time value.
B)​intrinsic value.
C)​fair value.
D)​premium.

Question 32

On April 4, Alam Company purchased a call option on 10,000 bushels of corn with delivery on June 30.The strike price is $2.15 per bushel.The value of the option and the market value of the corn are as follows. ?
$$\begin{array} { l r r } & \text { Value of the option } & \text { Value of the corn } \\ \text { Apri1 4 } & \$ 1,830 & \$ 20,400 \\\text { Apri1 30 } & 2,010 & 22,500 \\\text { May 31 } & 2,530 & 23,800 \\\text { June 30 } & 2,700 & 24,200\end{array}$$

A)On April 4, the intrinsic value of the option is $1,100.
B)On April 30, the time value of the option is $1,010.
C)On May 31, the intrinsic value of the option is $230.
D)On June 30, the time value of the option is $2,700.

Question 33

On May 11, McElroy Inc.purchased a call option on 5,000 bushels of wheat with delivery on August 31 for a premium of $750.The strike price is $1.85 per bushel.The values of the option at the end of May and June are $790 and $810, respectively.The option is sold on July 26 for $804.McElroy Inc.prepares quarterly and annual financial statements.Its year end is June 30.McElroy Inc.will

A)​recognize a gain on options of $60 on its fourth quarter income statement.
B)​recognize a gain on options of $20 on its fourth quarter income statement.
C)​recognize a gain on options of $40 on its fourth quarter income statement.
D)​record a gain on options of $54 in the July 26 entry to sell the option.

Question 34

Jenson Company buys 20 contracts on the Chicago Board of Trade to receive October delivery of soybeans to a certified warehouse.Each contract is in units of 3,000 bushels at a futures price of $2.75 per bushel.The owner of the contract requires a margin account with an initial margin of $8,000, with a maintenance margin of $6,000.What entry will Jenson Company make to establish the margin account?

A) A memo entry to record acquisition of the contract which has no value at inception.
B) $\begin{array}{llr} \text { Futures contract - margin account } &6,000\\ \text { Cash } &&6,000\\\end{array}$


C) $\begin{array}{ll}\text { Futures contract - margin account } & 8,000 \\\text { Cash } && 8,000\end{array}$

D) $\begin{array}{ll}\text { Futures contract - margin account } & 165,000 \\\text { Cash } && 165,000\end{array}$

Question 35

In order for a fair value hedge to receive special accounting treatment, the

A)​derivative instrument must be held until it expires or is exercised.
B)​criteria necessary for special accounting treatment must only be met at the inception of the hedge.
C)​entity may designate the derivative instrument as a fair value hedge when it is determined the hedge is effective.
D)​hedging relationship must be considered highly effective.

Question 36

Which of the following has an asymmetric return profile?

A)​Forward contracts
B)​Futures contracts
C)​Options
D)​Swaps

Question 37

On May 1 of the current year, Orr Company purchases a call option on 15,000 bushels of corn with delivery in July for a premium of $1,200 and a strike price of $3.05 per bushel.The values of the option at the end of May and June are $1,125 and $1,007, respectively.The option is sold on July 7th for $1,133.Orr Company prepares monthly financial statements.

A)​On May 1, Orr Company records a memo entry to record acquisition of the contract which has no value.
B)​For May, Orr Company records a gain on the contract of $75.
C)​For June, Orr Company records a loss of $193.
D)​At the sale of the option contract on July 7, Orr Company records a gain of $126.

Question 38

Interest rate swaps

A)​are a type of Futures Contract.
B)​are traded on the over-the-counter market.
C)​required an initial cash flow in the form of a margin.
D)​are customized to meet the needs of the specific parties.

Question 39

Which of the following is not true regarding using an option to hedge financial risks versus a forward contract?

A)​An option is a right to buy or sell an underlying, while a forward contract is an obligation.
B)​An option requires an initial cash outlay, while a forward contract does not.
C)​Both options and forwards are said to have asymmetric or one-sides return profiles.
D)​All of the above are true.

Question 40

A swap

A)​is not traded on an organized exchange and is customized to meet the needs of the parties.
B)​is not traded on an organized exchange and is subject to formal regulations which results in standardized contrasts
C)​is traded on an organized exchange and is subject to formal regulations which results in standardized contrasts.
D)​is traded on an organized exchange and is customized to meet the needs of the parties.

Question 41

At the beginning of 20X5, a derivative loss associated with a forecasted purchase of equipment will plus the expected cost of the equipment is $211,000.The fair value of the equipment is $199,000.The equipment has a useful life of 5 years.

A)​$12,000 should be included in Other Comprehensive Income in 20X5.
B)​$2,400 should be included in Other Comprehensive Income each year from 20X5 to 20X9.
C)​$12,000 should be included in Income in 20X5.
D)​$2,400 should be included in Income each year from 20X5 to 20X9.

Question 42

On March 1, 20X1, Adler Company issued a 5 year, $150,000 note at 7% fixed interest, payable semiannually on August 31st and February 28th.Based on the economic conditions on March 1, 20X3, Adler Company believes the interest rate will decline over the next few years.As a result Adler Company enters into an interest rate swap where it agrees to pay the LIBOR of 6.75% for the first 6 months.At the end of each 6-month period the variable rate will be reset to the current LIBOR.The LIBOR on September 1, 20X3 is 7.75%.
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Required:
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a.For August 31, 20X3 and February 28, 20X4, determine the net interest expense.?
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b.Identify the type of hedge.

Question 43

Explain how a derivative instrument may be used to reduce or avoid the exposure to risk associated with other transactions.

Question 44

On January 3, 20X4, Realto Company issued a $5,400,000, 3-year note payable with a fixed interest rate of 8% payable semiannually.By the end of June 20X5, Realto's controller, believed that interest rate would fall over the next year.On July 3, 20X5, Realto Company entered into an interest rate swap with the First Columbia Bank.The bank required a premium of $10,400.The swap had a notional amount of $5,400,000 and called for the payment of a variable interest rate in exchange for the 8% fixed rate.The variable rates are reset semiannually beginning on July 1, 20X5, in order to determine the next interest payment.Differences between rates on the swap will be settled on a semiannual basis.Variable interest rates and the value of the swap on selected dates are as follows:
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$$\begin{array} { l r r } & \text { Variable } & \\& \text { Interest } & \text { Value of } \\& \text { Rate } & \text { the Swap } \\\text { July } 1,20 \mathrm { X } 5 & 7.90 \% & \\\text { December } 31,20 \mathrm { X } 5 & 7.60 & \$ 18,900 \\\text { June } 30,20 \mathrm { X } 6 & 7.35 & 16,200\end{array}$$
Required:
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For December 31, 20X5, determine:
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a.The net interest expense.?
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b.The carrying value of the note payable.

Question 45

On February 1, Durham Company writes a forward contract to sell Rubright Company 3,000,000 yen at a specific, fixed price of $0.00875 per yen with delivery in 60 days.The spot rate at the end of the 60 days is $0.00913 per yen.The following is the forward rates information throughout the 60-day term.
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Assume the discount rate is 7%.
$$\begin{array} { l r r } \text { Remaining Term of Contract } & \text { Forward Rate } & \text { Notional Amount } \\\hline 60 \text { days } & \$ 0.00875 & 3,000,000 \\30 \text { days } & 0.00891 & 3,000,000 \\0 \text { days } & 0.00913 & 3,000,000\end{array}$$ ?
Required:
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a.Compute the gain or loss for Rubright Company over the life of the contract.?
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b.Assume the contract is settled at the end of the 60 days, prepare the journal entries to account for this contract on Rubright's books.

Question 46

During the second quarter of 20X5, Bertke Company entered into a futures contract that calls for the sale of 2,500 tons of soybean meal in July at a future price of $13.26 per ton.Bertke Company designated the contract as a hedge on a forecasted sale of soybean meal.The changed in the time value of the futures contract is excluded from the assessment of hedge effectiveness.The information regarding the contract and soybean meal is as follows:
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$$\begin{array} { l r r r r } & \text { April } 1 & \text { April 30 } & \text { May 31 } & \text { June 30 } \\\text { Spot price per ton } & \$ 13.21 & \$ 13.18 & \$ 13.14 & \$ 13.10 \\\text { Futures price per ton } & 13.16 & 13.12 & 13.11 & 13.05\end{array}$$ Required:
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Prepare a schedule to show the effect of this hedge on current earnings of Bertke Company.

Question 47

On January 1, 20X3, Shuey Company borrowed $1,000,000 at the fixed rate of 10% for 10 years with interest payable semi-annually.Shuey anticipates that interest rates will fall and has also arranged to receive a 10% rate of interest in exchange for the payment of variable rates based on LIBOR + 1.5%.LIBOR rates were as follows on the reset dates: ?

$$\begin{array} { l r r } & \text { LIBOR rate } & \text { FV of swap } \\\text { January } 1,20 \mathrm { X } 3 & 8.5 \% & \\\text { July } 1,20 \mathrm { X } 3 & 8.3 \% & \$ 40,000 \\\text { January } 1,20 \mathrm { X } 4 & 8.2 \% & \$ 38,000\end{array}$$ How much interest expense is recognized for the six months ended December 31, 20X3?

A)-$49,000
B)-$50,000
C)-$41,900
D)-$48,500

Question 48

North Shore Railroad operates between Chicago and upper Michigan and Wisconsin.Dallas Ingold, purchasing manager of North Shore Railroad, anticipates the price of diesel fuel will increase over the next few months.On September 4th, Ingold purchased an out-of-the-money November call option for $1,100.The option has a notional amount of 80,000 barrels and a strike price of $2.16 per barrel.Diesel fuel spot rates and option values at selected dates follow:
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$\begin{array}{lrr}& \text { Spot Rate } & \text { Option } \\\text { Date } & \text { per Barrel } & \text { Value } \\\text { September } 30 & \$ 2.17 & \$ 1,130 \\\text { October } 31 & 2.13 & 1,026 \\\text { November } 27 & 2.19 & 2,400\end{array}$

a.For each of the above dates, calculate the intrinsic value and the time value of the option.?
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b.If the price of diesel fuel remained below $2.16 per barrel through November, calculate the effect on earnings traceable to the hedge.

Question 49

Pearson Industries uses platinum in its manufacturing process.The company will need 1,500 troy ounces of platinum for a production run in June.The company is concerned that platinum prices will rise over the next several months.On May 14, in order to hedge against rising prices, Pearson Industries purchases 30 June call options on platinum.Each option is for 50 troy ounces and has a strike price of $477 per troy ounce.The company excludes changes in the time value of the options from hedge effectiveness.Spot prices and option value per troy ounce of platinum are as follows:
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$$\begin{array} { l r r r } & \text { May 14 } & \text { May 31 } & \text { June 8 } \\\text { Spot price } & \$ 479 & \$ 486 & \$ 492 \\\text { Option value per oz. } & 9.60 & 14.38 & 16.34\end{array}$$ On June 8, the company settled the options and on June 9 purchased 3,250 troy ounces of platinum on account for $493 per ounce.The platinum was used in the production process through the end of September.Platinum used during June was 325 troy ounces.Assume that the hedge satisfies all necessary criteria for special hedge accounting.
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Required:
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Prepare all journal entries necessary to account for the above transactions and events.

Question 50

All of the following are examples of cash flow hedges except:

A)​a hedge against a price increase in a raw material expected to be purchased in 60 days.
B)​a hedge against a fixed interest note payable using an interest rate swap.
C)​a hedge against a variable interest note payable using an interest rate swap.
D)​All of the above are examples of cash flow hedges.

Question 51

Jensen Company forecasts a need for 200,000 pounds of cotton in May.On April 11, the company acquires a call option to buy 200,000 pounds of cotton in May at a strike price of $0.3765 per pound for a premium of $814.Spot prices and options values at selected dates follow:
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$$\begin{array} { l r r r } & \text { April 11 } & \text { April 30 } & \text { May 3 } \\\text { Spot price per pound } & \$ 0.3718 & \$ 0.3801 & \$ 0.3842 \\\text { Fair value of option } & 814 & 1,137 & 1,689\end{array}$$ Jensen Company settled the option on May 3 and purchased 200,000 pounds of cotton on May 17 at a spot price of $0.3840 per pound.During the last half of May and the beginning of June the cotton was used to produce cloth.One third of the cloth was sold in June.The change in the option's time value is excluded from the assessment of hedge effectiveness.
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Required:
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a.Prepare all journal entries necessary through June to record the above transactions and events.?
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b.What would the effect on earnings have been if the forecasted purchase were not hedged?

Question 52

On August 9, Jacobs Company buys 25 contracts on Nymex to receive December delivery of Brent Crude Oil.Each contract is in units of 1,000 bbls at a futures price of $24.85 per bbl.The initial margin on the contract is set at $25,000, with a maintenance margin of $19,000.The futures prices are as follows:
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$$\begin{array} { r r r } \text { Aug. } 9 & \text { Aug. } 10 & \text { Aug. } 11 \\\$ 24.85 & \$ 24.63 & \$ 24.56\end{array}$$ Required:
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a.Journalize the entries for Jacobs Company for the first three days of the contract.?
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b.Why are forward prices discounted and future prices are not discounted?

Question 53

On August 1, an oil producer decided to hedge the fair value of its inventory by acquiring a futures contract to sell 100,000 barrels of oil on November 1 for $85.00 each.Price data follow: ?
$$\begin{array} { l r r } & \text { Spot Price } & \text { Futures Price } \\ \text { August 1 } & \$ 84.00 & \$ 85.00 \\\text { September 1 } & 82.80 & 83.50 \\\text { October 1 } & 82.20 & 82.40 \\\text { November 1 } & 81.00 & 81.00\end{array}$$ What is the current period change in time value that would be recognized in earnings as of October 1?

A)-$260,000
B)-$110,000
C)-$50,000
D)-$60,000

Question 54

Under special accounting treatment for cash flow hedge of a forecasted transaction, the relationship between the change in value of a derivative instrument and the change in value of the forecasted transaction affects the amount of gain (loss) that should be in Other Comprehensive Income (OCI).If the amount of gain on derivatives that is classified as OCI is $17,500 and the cumulative loss on the remaining forecasted transaction is ($13,200), the amount of OCI to be reclassified as a component of current earnings is

A)​$4,300.
B)​$13,200.
C)​$17,500.
D)​not applicable.

Question 55

On September 23, Gensil Company buys 40 contracts on the Chicago Board of Trade to deliver orange juice to a certified warehouse in November.Each contract is in units of 15,000 pounds at a futures price of $0.851 per pound.The initial margin on the contract is set at $18,000, with a maintenance margin of $14,000.The futures prices are as follows:
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$$\begin{array} { r r r } \text { Sept. } 23 & \text { Sept. } 24 & \text { Sept. 25 } \\\$ 0.851 & \$ 0.847 & \$ 0.850\end{array}$$
Required:
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a.Journalize the entries for Gensil Company for the first three days of the contract.?
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b.What is meant by the maintenance margin and how could it affect Gensil Company?

Question 56

Identify the various types of information that should be included in disclosures regarding derivative instruments and hedging.

Question 57

On June 30, 20X5, Adams Company had a $500,000, 7.4% fixed rate note due in 2 years.The note has been outstanding since May 26, 20X4 and the interest on the note is paid on June 30 and December 31 each year.The controller of Adams believed that interest rates would drop over the next two years, so he entered into a 2-year swap with Belmont National Bank to convert the fixed-rate note into a variable-rate note.According to the agreement, Adams Company will receive interest at a fixed rate of 7.4% and will pay a variable rate as determined by LIBOR.The LIBOR on June 30, 20X5 was 7.1%.The swap agreement calls for the variable rate to be reset each six months.The swap fair value on December 31, 20X5 was $6,300.
Required:
a.Present the journal entries, if any, to record the following events:
1.The entry to record the swap on June 30, 20X5.
2.The entries to record the semiannual interest payment on the debt and the settlement of the semiannual swap on December 31, 20X5.
3.The entries to record changes in fair value required by the above information on December 31, 20X5.
b.Present a partial balance sheet and income statement for the fiscal year ended December 31, 20X5 to include accounts affected by the above information.
Required:
​
a.Present the journal entries, if any, to record the following events:
​
​
​

Question 58

On July 1, 20X1, Littleton Inc.loaned a key supplier of raw material $2,000,000 to construct a new processing facility.The loan is due on July 1, 20X3 and pays interest each December 31 and June 30.The supplier insisted on a variable rate loan.Charles Upton, controller of Littleton Inc., wants to avoid the risk of variable interest rate fluctuations.As a result, Littleton Inc.entered into an interest rate swap in which it will pay the variable rate on $2,000,000 in exchange for a fixed interest rate of 8.3%.The swap is settled on the interest payment dates.Variable interest rates and the value of the swap on selected dates are as follows:
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$\begin{array}{lll}&\text { Variable } \\&\text { Interest }&\text { Value of } \\&\text { Rate }&\text { the Swap }\\\text { July } 1,20 \mathrm{X} 1 & 7.90 \% & \\\text { December } 31,20 \mathrm{X} 1 & 7.75 \% & \$ 10,400\end{array}$

Required:
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Prepare all entries to record this hedge through December 31, 20X1.

Question 59

Paton Company has an $11,000,000, note payable outstanding with a variable rate equal to LIBOR of 8.4% which matures on June 30, 20X3.The variable rates are reset each 6 months for the following 6-month period.The company believes that interest rates have bottomed, and they will begin to rise.At the end of June 20X1, Paton Company negotiated an interest rate swap with York National Bank of Bellingham that would allow Paton to pay a fixed rate of 7.75% in exchange for receiving interest based on the LIBOR.The swap is effective July 1, 20X1.The settlement date for the swap coincides with the company's interest payment dates.
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The criteria for special accounting have been satisfied, and the hedging relationship has been properly documented.Management of Paton Company has concluded that the hedge will be highly effective.Paton Company's fiscal year end is June 30.The LIBOR and swap values are as follows:
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$$\begin{array} { l r r } & \text { LIBOR } & \text { Swap Value } \\ \text { June } 30,20 \mathrm { X } 1 & 8.40 \% & \\ \text { December } 31,20 \mathrm { X } 1& 8.55 \% & \$ 19,300 \\\text { June } 30,20 \mathrm { X } 2& 8.10 \% & ( 8,010 )\end{array}$$
Required:
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Present the journal entries to record the above events from December 31, 20X1 through June 30, 20X2.
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Question 60

On January 1, 20X3, Shuey Company borrowed $1,000,000 at a variable rate based on LIBOR + 1.5% for 10 years with interest payable semi-annually.Shuey anticipates that interest rates will rise and has also arranged to receive a variable rate based on LIBOR + 1.5% in exchange for the payment of a 10% rate of interest.LIBOR rates were as follows on the reset dates: ?

$$\begin{array} { l r r } & \text { LIBOR rate } & \text { FV of swap } \\\text { January } 1,20 \mathrm { X } 3 & 8.5 \% & \\\text { July } 1,20 \mathrm { X } 3 & 8.7 \% & \$ 40,000 \\\text { January } 1,20 \mathrm { X } 4 & 8.8 \% & \$ 37,000\end{array}$$ How much interest expense is recognized for the six months ended December 31, 20X3?

A)-$51,500
B)-$50,000
C)-$51,000
D)-$51,200