XYZ has invested 1000000 in a debt security which it has cla

XYZ has invested $1,000,000 in a debt security, which it has classified as available-for-sale. The security pays a fixed rate of 7%. XYZ decides that a variable rate would be more advantageous while it holds this security, so it enters into an interest swap agreement with LMN Company.  The swap agreement specifies that XYZ will pay a fixed interest of 7% and receive variable interest, with settlement dates that match the interest payments on the security.  Assume that interest rates declined in 2017, and that XYZ had to pay $11,000 as an adjustment to the settlement at 12/31/17.  Because of the change in interest rates, the value of the security increased by $42,000 in 2017, but the value of the swap contract decreased by $42,000.

Prepare the journal entries required to record (a) the receipt of interest revenue on 12/31/17, (b) the payment of the swap settlement on 12/31/17, (c) the change in the fair value of the swap contract on 12/31/17, and (d) the change in the fair value of the available-for-sale debt security at 12/31/17.

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Solution

Date Account Title Debit Credit Dec-31 Cash 70000    Interest Revenue (1,000,000 * 7%) 70000 (To record the receipt of interest) Dec-31 Interest Revenue 11000    Cash 11000 (To record payment of the swap settlement) Dec-31 Unrealized Holding Gain or Loss 42000    Swap Contract 42000 (To record change in the fair value of the swap contract) Dec-31 Debt 42000 Unrealized Holding Gain or loss 42000 (To record the change in fair value of debt)