On 1 July 2005 Jarrets Ltd borrows £500,000 from a British bank at an interest rate of 8 per cent, repayable in pounds sterling (£) and with interest due on 30 June each year. The term of the loan is 3 years. On the same date Fitners Ltd borrows $A1 million from an Australian bank at an interest rate of 10 per cent. The term of the loan is 3 years. Jarrets and Fitners decide to swap their interest and principal obligations on 1 July 2005. Exchange rate information is as follows:

Both Jarrets and Fitners are Australian companies. What are the journal entries to record the swap for the period ended 30 June 2006 in Fitners Ltd's books (rounded to the nearest whole $A)?

Question

On 1 July 2005 Jarrets Ltd borrows £500,000 from a British bank at an interest rate of 8 per cent, repayable in pounds sterling (£) and with interest due on 30 June each year. The term of the loan is 3 years. On the same date Fitners Ltd borrows $A1 million from an Australian bank at an interest rate of 10 per cent. The term of the loan is 3 years. Jarrets and Fitners decide to swap their interest and principal obligations on 1 July 2005. Exchange rate information is as follows:

Both Jarrets and Fitners are Australian companies. What are the journal entries to record the swap for the period ended 30 June 2006 in Fitners Ltd's books (rounded to the nearest whole $A) ?

Both Jarrets and Fitners are Australian companies. What are the journal entries to record the swap for the period ended 30 June 2006 in Fitners Ltd's books (rounded to the nearest whole $A)?

Quizplus · Accepted Answer

Fitners Ltd's obligation to Jarrets Ltd for the period ended 30 June 2006 is to pay them £40,000 in interest (10% of £500,000) and to repay the loan principal of £500,000. However, due to the swap agreement, Fitners Ltd now owes the interest to the Australian bank instead of Jarrets Ltd. Therefore, the journal entries to record the swap should be:
- To record the interest payment to the Australian bank:
Interest expense (A)    Dr  $72,727
Interest payable (A)     Cr  $72,727
- To record the principal repayment to the Australian bank:
Loan payable (A)      Dr  $454,545
Foreign exchange gain (A)  Dr  $14,395
Cash (A)              Cr  $469,940
(Note that the foreign exchange gain of A$14,395 arises because the Australian dollar has appreciated against the pound sterling by 2%, as Fitners Ltd now has to repay £500,000 but only borrowed A$980,000 worth of Australian dollars.)

On 1 July 2005 Jarrets Ltd Borrows £500,000 from a British