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Answer :
Final answer:
Fontaine Corp records yearly entries for 5% interest on the note payable. Interest rate swap, linked to varying LIBOR rates, is considered, acting as a hedge against interest rate fluctuations.
Explanation:
The subject here is related to financial accounting and specifically to the field of interest rate swaps and notes payable. Since Fontaine Corporation issued an $800,000 notes payable at a fixed interest rate and entered into an interest rate swap to pay a floating rate and receive a fixed rate, the focus is on the accounting and journal entries required for an interest rate swap.
For the year 2023, Fontaine Corporation would need to make a journal entry to account for the interest expense on the note and the swap payment receipt. Assuming interest is calculated on an annual basis, the entries would consist of debiting interest expense at 5% of the principal ($800,000) and crediting interest payable.
On the swap side, considering the LIBOR rate at 6%, Fontaine Corporation would debit the interest expense for the swap and credit the payable for the swap. They would also have to debit cash to pay the net amount and credit interest expense.
In the consecutive years, the journal entries would similarly reflect the interest expenses for both the notes payable and the interest rate swap based on the given LIBOR rates. A critical point to note is that the actual journal entries would depend on the difference between the fixed payment and the floating payment received and paid out, respectively, as a result of the swap.
The fact that Fontaine Corporation has entered into this swap indicates a strategy to hedge against the risk of falling interest rates which, given the rising rates in successive years, protects the company's financial position against fluctuating interest costs.
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