1. American Italian Pasta Company (AIPC) manufactures several varieties of pasta. On January 1, 2020, AIPC had excess commodity inventories carried at acquisition cost of $1,000,000. These commodities could be sold or manufactured into pasta later in the year. To hedge against possible declines in the value of its commodities inventory, on January 6 AIPC sold commodity futures, obligating the company to deliver the commodities in February for $1,100,000. The futures exchange requires a $20,000 margin deposit. On February 19, the futures price increased to $1,150,000 and the company closed out its futures contract. Spot prices continued to rise and AIPC sold its inventory for $1,175,000 in cash on March 2.

Required

a. Prepare the journal entries related to AIPCs futures contract and sale of commodities inventory. Assume a perpetual inventory system, that spot and futures prices move in tandem, and the futures position qualifies for hedge accounting. All income effects for the inventories and related hedges are reported in cost of goods sold. (Options in the drop down are: Cash, Cost of goods sold, Inventory, Investment in futures, and sales revenue.)

2.

On July 1, 2020, Molson Coors Brewing Company borrowed $10 million for two years with interest paid semi-annually based on LIBOR adjusted semiannually. On that date, LIBOR is 2 percent per annum. To hedge against a possible rise in interest rates, on July 2 Molson Coors bought a two-year 2.05 percent interest rate cap for 0.075 percent per year, payable in full immediately. The intrinsic value of the cap is designated as the hedge instrument and the hedge is fully effective. The change in the caps time value is reported directly in income. LIBOR increased during the second half of 2020 and is reset to 2.15 percent for the first half of 2021. Molson Coors closes its books on December 31 and June 30. The caps fair value is $11,500 on December 31, 2020, before the rate adjustment, and is $13,500 on June 30, 2021.

Required

Prepare all journal entries related to the loan interest and the interest rate cap on July 2, 2020, December 31, 2020, and June 30, 2021.

3.

On July 1, 2020, Queen Corp. and Prince, Inc. entered into an interest rate swap on a notional amount of $1 million. They accepted the following offer of Intermediary:

To Intermediary from Queen		LIBOR + 30 (floating)
To Intermediary from Prince		2.4% (fixed)
To Queen from Intermediary		2.3% (fixed)
To Prince from Intermediary		LIBOR + 20 (floating)

At inception of the swap, LIBOR = 2.3 percent. Due to an increase of 20 bp in the floating interest rate at the end of September, Queen Corp. defaulted and Intermediary honored its commitment to Prince, Inc. by continuing with the swap.

Required

a. What monthly profit, in dollars, was Intermediary making on the swap before default?

Round answer to the nearest dollar.

$ per month

b. Is Intermediary losing money after the default?

No, the Intermediary is not losing money after the default.

Yes, the Intermediary is losing money after the default.

If the Intermediary is losing money, how much is it losing (per month)?

Do not use a negative sign with your answer. Round answer to the nearest dollar.

$ per month

4.

Suppose Apple, Inc. has $100 million of two-year floating rate debt outstanding at LIBOR + 80 bp. In a swap, Apple can get LIBOR + 80 bp from intermediary in return for fixed payments to intermediary at 4%. Alternatively, Apple could purchase a 4% interest rate cap for the two years remaining until the debt matures. LIBOR is currently 3%.

a. Assume LIBOR remains at 3% for the next two years. Compute the maximum amount Apple would pay for the cap and be indifferent between the swap and the cap. Ignore discounting.

$

Date Description Debit Credit 1/6/20 To record the initial margin deposit on the sale of commodity. 2/19/20 Cash To settle the contract. To adjust the carrying value of the hedged inventory for the change in fair value. 3/2/20 To record sale of commodities. To recognize the cost of sales. b. By how much would AIPC's profit increase if the hedge was not undertaken? Prepare all journal entries related to the loan interest and the interest rate cap on July 2, 2020, December 31, 2020, and June 30, 2021. Date Description Debit Credit 7/2/20 12/31/20 Cash Interest expense (gain in intrinsic value) Interest expense (gain in time value) Interest expense (loss in intrinsic value) Interest expense (loss in time value) Interest expense Investment in interest rate cap To recognize the decline in fair value of the time value portion of the premium 6/30/21 To record interest payable on the loan for the next six months. Investment in interest rate cap To record the net increase in fair value of the interest rate cap and loss of its time value. To record collection of the excess interest from the interest rate cap. Date Description Debit Credit 1/6/20 To record the initial margin deposit on the sale of commodity. 2/19/20 Cash To settle the contract. To adjust the carrying value of the hedged inventory for the change in fair value. 3/2/20 To record sale of commodities. To recognize the cost of sales. b. By how much would AIPC's profit increase if the hedge was not undertaken? Prepare all journal entries related to the loan interest and the interest rate cap on July 2, 2020, December 31, 2020, and June 30, 2021. Date Description Debit Credit 7/2/20 12/31/20 Cash Interest expense (gain in intrinsic value) Interest expense (gain in time value) Interest expense (loss in intrinsic value) Interest expense (loss in time value) Interest expense Investment in interest rate cap To recognize the decline in fair value of the time value portion of the premium 6/30/21 To record interest payable on the loan for the next six months. Investment in interest rate cap To record the net increase in fair value of the interest rate cap and loss of its time value. To record collection of the excess interest from the interest rate cap