Question #$4$

Emmett Ltd$.$ has a floating rate bond with a total face value of $$1,000,000,$ with semi$-$interest payment on June $30$ and December $31.$ On January $1,2023,$ Emmett entered into an interest rate swap with First Bank whereby it agrees to pay interests on $$1,000,000$ at a fixed rate of $7\%($the current interest rate$)$ and to receive payments based on the floating rate. On June $30,2023,$ the floating interest rate is $6\%.$ On December $31,2023,$ Emmett$$s SFP date, the floating interest rate is $9\%,$ and the value of the swap contract is $$40,000$ to Emmett$$s benefit.

Instructions

$1.$ What is the hedged item? What is the hedging item? How does the hedge reduce the risk?

$2.$ Assume hedge accounting option is elected, and the swap is a cash flow hedge, prepare any journal entries required related to the swap agreement and the interest payment on the bond on the following dates:

a$)$ January $1,2023$

b$)$ June $30,2023$ interest payment to the bondholders and the net settlement of interest swap with First Bank. Determine the interest of the six$-$month period from January to June.

c$)$ December $31,2023$ interest payment to the bondholders AND the net settlement of interest swap with First Bank. Determine the interest of the six$-$month period from July to December.

d$)$ December $31,2023$Record swap contract asset$/$liability first, and then make necessary adjustment required under the hedge accounting.