On January 1, 2021, JPS Industries borrowed $300,000 from Austin Bank by issuing a three-year, floating rate note based on LIBOR, with interest payable semi-annually on June 30 and December of each year. JPS entered into a three-year interest rate swap agreement on January 1, 2021, and designated the swap as a cash flow hedge. The intent was to hedge the risk that interest rates will rise, increasing its semi-annual interest payments. The swap agreement called for the company to receive payment based on a floating interest rate on a notional amount of $300,000 and to pay a 6% fixed interest rate. The contract called for cash settlement of the net interest amount semi-annually, and the rate on each reset date (June 30 and December 31) determines the variable interest rate for the following six months. LIBOR rates in 2021 were 6% at January 1, 5.5% at June 30, and 7% at December 31. The fair values of the swap on those dates, obtained by dealer quotes, were as follows:
January 1June 30 December 31
Swap fair value $0 $(3,100) $4,000
Required:
1. Calculate the net settlement on June 30, 2021.
2. Prepare journal entries for the period January 1 to December 31, 2021, to record the note payable and hedging instrument, necessary adjustments for changes in fair value, and settlement of the swap contract.

Explanation:

1)

To determine the net settlement;

For June 30th:

The net cash receipt = receiving floating interest - pay fixed interest

For December 31st:

Net cash receipt =

2)

Date           General Journal                        Debit ($)       Credit($)

Jan 1   Cash   Account/current (A/C)        300000

          Note Payable Account/current                             300000

                    To record the debt

June 30    Interest expense A/C

                                     9000

                  To cash   A/C                                                      9000

June 30    other huge income (A/C)

                 (3100 - 0)                                      3100            

                   Interest rate swap                                            3100

                To record the change in

                 derivative fair value

               At June 30, 2021;

             Since the cash settlement is

             focused on beginning-of-year

             rates (when both fixed and floating

             rates were 6%), there is no cash

             exchanged for interest rate swap

             settlement. It does recognize a fall in the

            the fair value of the interest rate trade in the

            following  half-year because of lower

            interest rates. Other comprehensive huge

             income is calculated to reflect the decline

             in fair value.

Dec 31    Interest expense A/C

                                        8250

                 To cash  A/C                                                               8250

                 To record interest

Dec 31         Interest expense A/C

                               750

                 To cash  A/C                                                               750

                 To record net cash settlement

Dec 31         Interest rate swap A/C                   7100

                    other huge income                                                 7100

                    To record change in derivative

                     of the fair value

                     $3100(June 30) + $4000(Dec 30)

                      (Fair value swap)