On 4 January x1 firm B has purchased a corporate bond for 100 000 US$ (= face/par value, annual interest payments) with a fixed nominal interest rate (i = 7%). The bond is categorized as available-for-sale. In order to hedge itself against changes in the fair value, the company purchases at the same time a market-priced payer interest swap (interest adjusted once a year: LIBOR + 350 basis points). By 31 December x1, the LIBOR has decreased, the swap has a positive fair value of 12 000 US$. The fair value of the corporate bond has decreased by 13 000 US$. Firm B assesses the issuers default risk and concludes that there are expected credit losses of 1 000 US$.

Calculate effectiveness according to the dollar offset method. Provide the journal entries as of January 4 x1 and December 31 x1, assuming that firm B:

a) does not apply fair value hedge accounting,

b) does apply fair value hedge accounting after having designated the risk of changes in the fair value of the bond due to changes in market interest rates as the hedged risk.