Question
On January 1, 2024, Oriole Company purchased $526,000 of Nest Corporations five-year, 4% notes at par, with interest receivable semiannually. The company classified the investment
On January 1, 2024, Oriole Company purchased $526,000 of Nest Corporations five-year, 4% notes at par, with interest receivable semiannually. The company classified the investment as available-for-sale.
To hedge the risk that general interest rates will increase and the fair market value of its investment in AFS debt securities will decrease, Oriole entered into a five-year plain vanilla interest rate swap agreement on January 1, 2024, and designated the swap as a fair value hedge.
The agreement called for the company to make payments based on a 4% fixed interest rate on a notional amount of $526,000 and to receive interest based on a floating interest rate (SOFR). The contract called for cash settlement of the net interest amount semiannually on June 30 and December 31, based on beginning-of-period rates.
Oriole qualifies for and elects to use the shortcut method.
Floating (market) settlement rates were 3% at June 30, 2024, 5% at December 31, 2024, and 5.5% at June 30, 2025. The fair values of the swap on those dates are quotes obtained from a derivatives dealer and are listed below.
1/1/24 | 6/30/24 | 12/31/24 | 6/30/25 | |
---|---|---|---|---|
Interest revenueAFS security | $ 10,520 | $ 10,520 | $ 10,520 | |
Fixed rateswap | 4% | 4% | 4% | 4% |
Floating rateswap | 4% | 3% | 5% | 5.5% |
Fair value of interest rate swap | $ 0 | $ (21,988) | $ 18,857 | $ 24,811 |
Required:
Calculate the net cash settlement at June 30 and December 31, 2024, and June 30, 2025.
Prepare the journal entries through June 30, 2025, to record the investment in available-for-sale debt securities, interest, and necessary adjustments for changes in fair value.
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