On January 2, 2014, Thompson Corp. issued a $100,000, four-year note at prime plus 1% variable interest, with interest payable semi-annually. On the same date, Thompson entered into an interest rate swap where it agreed to pay 6% fixed and receive prime plus 1% for the first six months on $100,000. At each six-month period, the variable rate will be reset. The prime interest rate is 5.7% on January 2, 2014, and is reset to 6.7% on June 30, 2014. Thompson follows ASPE and uses hedge accounting. Assume that the swap qualifies for hedge accounting under ASPE.
Instructions
(a) Calculate the net interest expense to be reported for this note and the related swap transaction as of June 30 and December 31, 2014.
(b) Prepare the journal entries relating to the interest for the year ended December 31, 2014.
(c) Explain why this is a cash flow hedge.