On January 2, 2011, Parton Corp. issues a $10-million, five-year note at LIBOR, with interest paid annually. The variable rate is reset at the end of each year. The LIBOR rate for the first year is 5.8%. Parton later decides that it prefers fixed-rate financing and wants to lock in a rate of 6%. As a result, Parton enters into an interest rate swap to pay 6% fixed and receive LIBOR based on $10 million for the remainder of the term of the note. The variable rate is reset to 6.6% on January 2, 2012.
Instructions
(a) Calculate the net interest expense to be reported for this note and related swap transactions as of December 31, 2011, and 2012.
(b) Prepare the journal entries relating to the swap for the years ended December 31, 2011, and 2012.
(c) Explain why this is a cash flow hedge.