On January 1, 2021, Labtech Circuits borrowed $108,000 from First Bank by issuing a three-year, 9% note, payable on December 31, 2023. Labtech wanted to hedge the risk that general interest rates will decline, causing the fair value of its debt to increase. Therefore, Labtech entered into a three-year interest rate swap agreement on January 1, 2021, and designated the swap as a fair value hedge. The agreement called for the company to receive payment based on an 9% fixed interest rate on a notional amount of $108,000 and to pay interest based on a floating interest rate tied to LIBOR. The contract called for cash settlement of the net interest amount on December 31 of each year. Floating (LIBOR) settlement rates were 9% at inception and 10%, 8%, and 8% at the end of 2021, 2022, and 2023, respectively. The fair values of the swap are quotes obtained from a derivatives dealer. Those quotes and the fair values of the note are as follows:

	January 1			December 31
	2021			2021			2022			2023
Fair value of interest rate swap		0		$	(1,800	)	$	1,000		$	0
Fair value of note payable	$	108,000		$	106,200		$	109,000		$	108,000

1. Calculate the net cash settlement at the end of 2021, 2022, and 2023.

	December 31
	2021	2022	2023
Net interest receipts (payments)

2. Prepare the journal entries during 2021 to record the issuance of the note, interest, and necessary adjustments for changes in fair value.

1. Record the issuance of the note 2. Record the interest. 3. Record the net cash settlement, accrued interest on the swap, and change in fair value of the derivative. 4. Record the change in fair value of the note due to interest.

Note: Enter debits before credits.

Date	General Journal	Debit	Credit
January 01, 2021

3. Prepare the journal entries during 2022 to record interest, net cash interest settlement for the interest rate swap, and necessary adjustments for changes in fair value.

1. Record the interest. 2. Record the net cash settlement, accrued interest on the swap, and change in fair value of the derivative. 3. Record the change in fair value of note due to interest.

4. Prepare the journal entries during 2023 to record interest, net cash interest settlement for the interest rate swap, necessary adjustments for changes in fair value, and repayment of the debt. 1. Record the interest. 2. Record the net cash settlement, accrued interest on the swap, and change in fair value of the derivative. 3. Record the change in fair value of the note due to interest. 4. Record the repayment of the loan.

5.

Calculate the book values of both the swap account and the note in each of the three years. (Round your intermediate values and final answers to the nearest whole dollar.)

Date	Swap Balance		Note Balance
December 31, 2021		Credit		Credit
December 31, 2022
December 31, 2023

6. Calculate the net effect on earnings of the hedging arrangement in each of the three years. (Ignore income taxes.) (Negative amounts should be indicated by a minus sign. Round your intermediate values and final answers to the nearest whole dollar.)

	Net effect on earnings
2021
2022
2023

7. Suppose the fair value of the note at December 31, 2021, had been $107,000 rather than $106,200 with the additional decline in fair value due to investors perceptions that the creditworthiness of Labtech was worsening. How would that affect your entries to record changes in the fair values?

1. Record the interest. 2. Record the net cash settlement, accrued interest on the swap, and change in fair value of the derivative. 3. Record the change in fair value of the note due to interest.