25E (Cash Flow Hedge) On January 2, ... [FREE SOLUTION]

Chapter 13: 25E (page 658)

(Cash Flow Hedge) On January 2, 2017, Parton Company issues a 5-year, $10,000,000 note at LIBOR, with
interest paid annually. The variable rate is reset at the end of each year. The LIBOR rate for the first year is 5.8%.
Parton Company decides it prefers fixed-rate financing and wants to lock in a rate of 6%. As a result, Parton enters into an
interest rate swap to pay 6% fixed and receive LIBOR based on $10 million. The variable rate is reset to 6.6% on January 2, 2018.
Instructions
(a) Compute the net interest expense to be reported for this note and related swap transactions as of December 31, 2017.
(b) Compute the net interest expense to be reported for this note and related swap transactions as of December 31, 2018.

Expert verified

In this, first of all, the Interest paid by Parton is calculated,

$\begin{array}{rcl} Interest Payment & = & notes amount 脳 interest rate \\ = & $ 10, 000, 000 脳 6 % \\ = & $ 600, 000 \end{array}$

Now, the payment received is calculated.

$\begin{array}{rcl} Interest Received & = & notes amount 脳 interest rate \\ = & $ 10, 000, 000 脳 5.8 % \\ = & $ 580, 000 \end{array}$

In this, the amount paid as interest is more than the interest received; hence, Parton receives $20,000 interest on the settlement.

Interest paid by Parton is $600,000. After this, the interest received by Parton is calculated.

$\begin{array}{rcl} Interest Received & = & amount of notes 脳 interest rate \\ = & $ 10, 000, 000 脳 6.6 % \\ = & $ 660, 000 \end{array}$

This amount received is greater than the amount paid; hence, the interest expense is $60,000.

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NEW YORK BOUTIQUE TRIAL BALANCE DECEMBER 31
	Debit	Credit
Cash	\( 18,500
Accounts Receivable	32,000
Allowance for Doubtful Accounts		\) 700
Inventory, December 31	80,000
Prepaid Insurance	5,100
Equipment	84,000
Accumulated Depreciation鈥擡quipment		35,000
Notes Payable		28,000
Common Stock		80,600
Retained Earnings		10,000
Sales Revenue		600,000
Cost of Goods Sold	408,000
Salaries and Wages Expense (sales)	50,000
Advertising Expense	6,700
Salaries and Wages Expense (administrative)	65,000
Supplies Expense	5,000
	\(754,300	\)754,300