Chapter 1 Problem 14-9
2008
Jan. 31 Cash 1,000,000
Note payable 1,000,000
Dec. 31 Interest expense (1,000,000 x 8%) 80,000
Cash 80,000
31 Note payable 34,760
Gain on note payable 34,760
On every year-end the note payable is measured at fair value. The fair value is
equal to the present value of the principal plus the present value of future interest
payments.
PV of principal (1,000,000 x .8264) 826,400 PV of interest (80,000 x 1.7355) 138,840 Fair value of note payable – 12/31/2008 965,240
Carrying value of note payable 1,000,000
Decrease in carrying value – gain 34,760
31 Loss on interest rate swap 34,760
Interest rate swap payable 34,760
The derivative which is the interest rate swap is also measured at fair value. The
fair value is equal to the present value of the net cash settlement with the
speculator.
Variable interest (1,000,000 x 10%) 100,000
Fixed interest (1,000,000 x 8%) 80,000
Net cash payment to speculator 20,000
Multiply by PV of an ordinary annuity of 1 at 10% for two periods 1.7355
Fair value of interest swap payable – 12/31/2008 34,760*
*20,000 times 1.7355 equals P34,760. There is a difference of P50 due to rounding.
The gain on note payable and the loss on interest rate swap are recognized immediately in profit or loss because the interest rate swap is designated as fair
value hedge.
2009
Dec. 31 Interest expense 96,524
Cash 80,000 Note payable 16,624
Actually, on December 31, 2008, there is a discount on note payable because
the fair value is P965,240 and the face value is P1,000,000. This discount is
amortized using the effective interest method.
Interest expense (965,240 x 10%) 96,524 Interest paid (1,000,000 x 8%) 80,000
Amortization of discount – increase in note payable 16,524
31 Note payable 8,792
Gain on note payable 8,792
PV of principal (1,000,000 x .9009) 900,900 PV of interest payment (80,000 x .9009) 72,072
Fair value of note payable – 12/31/2009 972,972
Carrying value of note payable (965,240 – 16,524) 981,764
Decrease in carrying value – gain 8,792
31 Interest rate swap payable 20,000
Cash 20,000
This is the cash payment to the speculator as a result of the increase in market
rate of interest on January 1, 2009.
31 Loss on interest rate swap 12,267
Interest rate swap payable 12,267
Variable interest (1,000,000 x 11%) 110,000
Fixed interest (1,000,000 x 8%) 80,000
Net cash payment to speculator 30,000
Multiply by PV of 1 at 11% for one period .9009
Fair value of interest rate swap payable – 12/31/2009 27,027
Carrying value of interest rate swap payable (34,760 – 20,000) 14,760
Increase in interest rate swap payable 12,267
2010
Dec. 31 Interest expense 107,028
Cash 80,000 Note payable 27,028
Interest expense (972,972 x 11%) 107,028*
Interest paid 80,000
Amortization of discount 27,028
*972,972 x 11% equals P107,027 or a difference of P1 due to rounding to bring the carrying value of the note payable to P1,000,000 on maturity date.
31 Loss on interest rate swap 2,973
Interest rate swap payable 2,973
Final cash payment to speculator 30,000
Carrying value of interest rate swap payable 27,027
Loss on interest rate swap 2,973
31 Interest rate swap payable 30,000
Cash 30,000
Final settlement with the speculator.
31 Note payable 1,000,000
Cash 1,000,000
Repayment of the loan to the bank.
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