CHAPTER 46 DERIVATIVES Interest rate swap Problem 46-1 (IAA) On January 1, 2018, Pasay Company entered into a two-year P3,000,000 variable interest rate loan at the prevailing rate of 12%, In 2019, the interest rate is equal to the prevailing interest rate at the beginning of the year, The principal loan is payable oa December 31, 2019 and the interest is payable on December 31 uf each year. On January 1, 2018, Pasay Company entered into a “receive variable, pay fixed” interest swap agreement with a speculator bank designated as a cash flow hedge. The prevailing interest rate on January 1, 2019 is 14% and the present value of | at 14% for one period is .877. 1, What amount should be reported as interest rate swap receivable on December 31, 2018? a. 60,000 b. 52,620 ce. 30,000 d. 0 2. What amount should be reported as interest expense for 2019? a. 360,000 b. 420,000 ©. 390,000 4. 323,400: ‘ hich is 2% higher 1, 2018 is 1496 any shall the ed ate of 12% 1 mes ha a ive P60,000 from the bank on De > derivative asset on December This réceivable is recognized as a 50 computed by multiplying 31, 2018 at present value of P52,6 P60,000 by .877. Question 2. Answer a Interest expense for 2019 (12% x-3,000,000) 360,000 Journal entries 2018 Jan.. 1 Cash 3,000,000 Loan payable 3,000;000 Dec. 31 Interest expense 360,000 Cash 360,000 31 Interest rate swap receivable 52,620 Unrealized gain — OCI 52,620 2019 Dec. 31 Cash 60,000 Interest rate swap receivable 52,620 Unrealized gain - OCI 7,380 31 Interest expense (14% x 3,000,000) 420,009 Cash 420,000 31 Unrealized gain - OCI 60,000 Interest expense 60,000 31. Loan payable 3,000,000 Cash 3,000,000 a" Problem 46-2 (IAA) Imus Company received a two-year variable interest rate loan of P5,000,000 on January 1, 2018. : The interest on the loan is payable on December 31 of each year and the principal is to be repaid on December 31, 2019. On January 1, 2918, Imus Company entered into a “receive variable, pay fixed” interest rate swap agreement with a speculator bank designated as a cash flow hedge. The interest rate for 2018 is the prevailing interest rate of 10% and the rate in 2019 is equal to the prevailing rate on January 1, 2019. The market rate of interest on January 1, 2019 is 7% and the present -value of | at 7% for one period is .935. i. What amount should be reported as interest rate swap payable on December 31, 20187 a. 150,000 b. 140,250 c. 100,000, d. 0 2. What amount should be reported as interest expense for 2019? 500,000 350,000 150,000 467,500 peopb the interest rate on January 1, the fixed rate of 10%, it means : Ln bank PI50,000 on December 31, i ich is 3% lower 2019 is 7% which is 3 that Imus Company shall pay 2019 or P5,000,000 times The interest rate swap payable is recognized as a derivative liability on December 31, 2018 at present value. ‘The present value is equal to P150,000 multiplied by .935 or P140,250. Question 2. Answer a Interest expense for 2019 (10% x 5,000,000) 500,000 ‘The interest expense each year is locked in at the underlying fixed rate of 10%. Journal entries 2018 Jan. 1 Cash 5,000,000 Loan payable 5,000,000 Dec. 31 Interest expense 500,000 Cash . 500,000 31. Unrealized loss - OCI 140,250 Interest rate swap payable 140,250 2019 : Dec. 31 Interest rate swap payable 140,250 Unrealized loss - OCI 9,750 Cash 150,000 31 _ Interest expense (7% x 5,000,000) 350,000 i Hey Cosh 350,000 31 + Interest expense 150,000 Unrealized loss - OCI 31 Loan open 5, 000,000The interest Tate for 2018 is 8% and the rate in each succeeding year is equal to market interest rate on J anuary 1 of each year. On Ji january 1.2018, Taal Company entered into a “receive variable Pay fixed” interest rate swap agreement with a financial institution. The swap payments are made at the end of the year. This interest tate swap agreement is designated as [Link] flow hedge. On January 1, 2019, the market rate of interest is 9%. The present value of an ordinary annuity of | at 9% for four periods is 3.24. On January 1, 2020, the market rate of interest is 12%. The present vaiue of ano y annuity of 1 at 12% for three periods is 2.40. 1. On December 31, 2018, what amount should be reported as interest rate swap receivable? a. 300,000 » b. 249,000 c. 194,400 d. 120,000 2. On December 31, 2019, what amount should be reported as interest rate swap receivable? a. 720,000 b. 777,600 c. 576,000 d. 240,000 3. What is the interest expense for 20197 a. 720,000 . 540,000: ‘Question 1 Answer c The interest rate on January 1, 2019 is 9% which is 1% higher than the fixed rate of 8%. This means that Taal Company shall re ive an anual interest swap payment from the finaacial institution of P6,000,000 tiles 1% or P60,000. Since the termn of the loan is 5 years and one yeat already expired, Taal Company shal] receive P60,000 at the end of 201 9 expect to receive P60,000 at the erid of 2020, 2021 and 2 Thus, the present value of the four annual paymcuts of P6O.000 is recognized as interest rate swap receivable on December 31, 2018 ,or P60,000 times 3.24 equals PI 94.460. Question 2 Answer c The interest rate on January 1, 2020 is 12% which is 4% higher than the underlying fixed rate of 8%. This means that Taal! Company shall receive an inte: from the financial institution of P6,000,000 mui P240,000. swap payin iplied by 4% or Since the term of the loan is 5 years and iwo years already ex d Taal Company shail receive P240,000 at the end of 2020 and can expect to receive P240,000 at the end of 2021 and 2022 Thus, the present value of three annual payments of P2 10,000 is recognized as interest rate swap receivable on December 3 1 2019 or P240,000 times 2.40 equals P576,090, , Question 3 Answer c Interest expense for 2019 (8% x 6,000,000) The interest expease each year is locked in at the underly ing fixed ‘rate of 8%.n January 1, 2018, Aloha Company received a four-year '5,000,000 loan with interest payments occurring at the end of each year and the principal to be repaid on December.31, 2021. - The interest for 2018 is the prevailing market rate of 10% onJ january 1, 2018, and the market interest rate every January | resets the variable rate of interest for that year. The “underlying” fixed interest rate is 10%. In conjunction with the loan, the entity entered into a“receive variable, pay fixed” interest rate swap agreement with a financial institution as cash flow hedge. The interest swap peyment will be made on December 31 of cach year. The market January |. te of interest is 6% on January 1, 2019 and 8% on The PV of en ordinary annuity of | at 6% for three periods is 2.67 and the PV of an ordinary annuity of 1 at 8% for two periods is 1.78. 1. What is the derivative asset or liability on December 31, 2018? 2. 600,000 t b. 600,000 Liat c. $34,060a: d. 534,000 liability 2. What is the derivative asset or liability on December 31, 2019? a. 178,[Link] b. 178,000 liability c. 334,060 asset d, “334,000 liability 3. What amount of interest expense should be reported for 2019? a, 500,000 © b.” 300,000 400,000 136,000Rees ‘ Feat January 1, 2019 is 6% which is 4% lower than Jying fixed rate of 10%. means that Aloha Company shall make an annual interest swap : payment to the financial institution of P5,000,000 tires 4% or -P200,000. Since the term of the loan is 4 years and one year already expired, Aloha Company shall pay P200,000 at the end of 201 9 and can expect to pay P200,000 ai the end of 2020 and 2921. Thus, the present value of the three annual payments of #200,600 is recognized as interest rate swap payable on December 31, 2618 or P200,000 times 2.67 equals P534,000 Question 2 Answer b The interest rate on January 1, 2020 is 8% which is 2% lower than the underlying fixed rate of 10%. This means that Alcha Company shall make an annual swap peyment to the financial institution of 5,000,000 times 2% or P190,000 Since the term is 4 years and two years already expired, Aloha Company shall pay P 100,00 at the end of 2020 and can expect to pay P100,000 at the end of 2020. “ Thus, the present value of the two annual payments of P100,090 is recognized as interest raie swap payable on December 31, 2019 or P100,000 times 1.78 or P178,000, Question 3 Answer'a Interest expense for 2019 (10% x 5,000,000) “500. 000 oe expense every year is locked in at the underlying fixed: ‘O. © oe vemn 46-5 (LAA) aE On January 1, 2018, Trece Company borrowed P5,000,000 bark at a variable rate of interest for 4 years. Interest will be annually to the bank on December 31 and the principal j Paid bert 2b on Dec Principal is due on Under the agreement, the market rate of interest évery January I resets ‘the variable 1ate for that petiod and the amount of interest to be paidon December 31. In cosjunction with the loan, Trece Company entered into a “receive variable, pay fixed” interest rate swap agreement with another bank specutlator. The interes swap agreement was designated asacash flow hedge. The market rates of intevest are: Janwary 1, 2018 19% January 1, 2019 14% January 1, 2020 12% January 1,202! 11% The PV ofan ordinary annvity of | is 2.32 4 for three periods, 1.69 at 12% for two periods and 0.90 ai 1¢ period, 1. Whatis the notional of the interest rate sway eraent? d 500,000 2. What is the derivative asset or liability on Beecmber 31, 2018? a. 464,000 asset b. 464,006 liability c. 600,000 asset d. 600,900 liability 3. What is the derivative asset or liability on December 31, 2019? a. 200,000 asset b. 200,000 liability ¢. 169,000 asset -d. 169,000 liability What is the derivative asset or liability on December 31, 2020?principal amount of the loan or PS,000,000 “Question 2? Answer a The interest rate on January |, 2019 is 14% which is 4% higher than the underlying fixed rate of 10% receive a swap pay ment from This means that Trece Company s' the bank of 4% times P5,000,000 0 2020 and 292'. 2.32 or P464,000. Phis amornt is 2018 as interest rate swop recery Question 3 Answer « The imteies the under lyin; This means tt bank of 24 2021. The present valu payments is PEGS 1.69 or P169, une ius? be receivable on December 31, 2019. times PS Question 4 Answer a The interest rate on January 1, 262 than the underlying fixed rate of }0% hich is 1% bigher This means that Trece Corapany shal] receive a swap pa’ : 1 y shal] rec a ment of 1% times P5,000.600 or P50,000 on Deceinber 3 1. 2021 r wee The an value of the P50.000 payment is P50,000 times 90 or (5,000. This amount must be the in:erest rate swa: ; lela 31,2026, ip receivable