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E. Primary Financial Reporting Methods
1. Overview
The primary financial reporting alternatives for valuing
nonhedging swaps are amortized cost, current market value, and
lower of cost or market value (lower of cost or market). The
latter two alternatives use market value information and allow
unrealized gains and losses to be either (1) recognized as
current income on the income statement or (2) accumulated on the
balance sheet in a separate component of shareholders’ equity
until realized.
2. Amortized Cost
Under the amortized cost method, the initial cost of a
typical interest rate swap is zero; swaps generally have no
cashflow at inception. On each financial reporting date, income
or loss on the swap is accrued in an amount equal to the portion
of the next scheduled cashflow that reflects the elapsed time as
of the reporting date. An offsetting entry is made to a
receivable or payable, which is the only balance sheet evidence
of the swap. On cashflow dates, entries are made to record the
cash received or paid, reverse the receivable or payable, and
record the balance as income or loss. Income over the life of
the swap equals the total cashflows.
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