On January 1, 2021, JPS Industries borrowed $300,000 from Austin Bank by issuing a three-year, floating rate note based on LIBOR, with interest payable semi-annually on June 30 and December of each year. JPS entered into a three-year interest rate swap agreement on January 1, 2021, and designated the swap as a cash flow hedge. The intent was to hedge the risk that interest rates will rise, increasing its semi-annual interest payments. The swap agreement called for the company to receive payment based on a floating interest rate on a notional amount of $300,000 and to pay a 6% fixed interest rate. The contract called for cash settlement of the net interest amount semi-annually, and the rate on each reset date (June 30 and December 31) determines the variable interest rate for the following six months.
LIBOR rates in 2021 were 6% at January 1, 5.5% at June 30, and 7% at December 31. The fair values of the swap on those dates, obtained by quotes, were as follows:
Required:
1. Calculate the net settlement on June 30, 2021.
2. Prepare journal entries for the period January 1 to December 31, 2021, to record the note payable and hedging instrument, necessary adjustments for changes in fair value, and settlement of the swap contract.
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