Question

On January 2, 2017, Pharoah Co. issued a 4-year, $126,000 note at 6% fixed interest, interest payable semiannually. Pharoah now wants to change the note to a variable-rate note. As a result, on January 2, 2017, Pharoah Co. enters into an interest rate swap where it agrees to receive 6% fixed and pay LIBOR of 5.80% for the first 6 months on $126,000. At each 6-month period, the variable rate will be reset. The variable rate is reset to 6.70% on June 30, 2017. (a) Compute the net interest expense to be reported for this note and related swap transaction as of June 30, 2017.

Answer 1

Answer:

interest expense   3,654 debit

               cash                     3,654 credit

Explanation:

For the first 6 month the note will pay 5.80% interest for the subsequent 6 month will pay at 6.70%

We do for the period Jan 2,2017 to June 30,2017

variable LIBOR rate:

126,000 x 5.80% / 2 = 3654

fixed rate of the promissory note:

126,000 x 6.00% / 2 =3,780

difference:                      126 in our favor.

We pay the variable rate, not the fixed rate. THerefore, we made the entry for the variable rate