Australia why is interest rate swaps added to variable rate debt to get net variable rate?

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I'm an engineering phd trying to fathom my way into business and accounting, and was hoping to post questions here more frequently as I try to make my way through financial reports. For a layman I would consider myself quite savy at accounting, but there are many things I really don't understand nor have the background for, and my first is this:

The financial statement of the company I am reading about reports the following:

variable rate debt: $679,588,000
net settled derivatives
(interest rate swaps): $6,091,000
net variable rate liabilities: $685,679,000

given that the company engaged in interest rate swaps to reduce its variable rate liability (ie. it is the buyer of the derivatives as I understand it), shouldn't the interest rate swaps be DEDUCTED from the variable rate debt to yield the net variable rate liability, rather than being added to it?

does net variable rate liability not mean the amount of debt that is effectively at a variable rate (ie not being offset by the swaps)?

thanks in advance :)
 
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bklynboy

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An interest rate swap (swapping variable for fixed payments) doesnt always ruduce the liability for book purposes. The point of the swap is to lock in a known fixed cashflow. If rates have declined since the swap was entered into then this generates a MTM loss which increases the liability (i.e. the settlement cost at that point in time). For instance if at the date of the swap the variable rate was 2% above LIBOR ( say LIBOR was 2%) and the swap locks in a fixed rate of 4% then at inception there is no gain or loss. Subsequently, LIBOR drops to 1% - the value of the swap has now declined since the derivative is now worth less to a buyer and this loss on the derivative I think is what they are adjusting for. Note that the company doesnt really care about the value of the swap as this is just a book loss and is really just trying to lock in a known cash flow. However, if it wants to terminate the swap then it must pay for that loss which is what is being reflected as the higher liability.
 
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An interest rate swap (swapping variable for fixed payments) doesnt always ruduce the liability for book purposes. The point of the swap is to lock in a known fixed cashflow. If rates have declined since the swap was entered into then this generates a MTM loss which increases the liability (i.e. the settlement cost at that point in time). For instance if at the date of the swap the variable rate was 2% above LIBOR ( say LIBOR was 2%) and the swap locks in a fixed rate of 4% then at inception there is no gain or loss. Subsequently, LIBOR drops to 1% - the value of the swap has now declined since the derivative is now worth less to a buyer and this loss on the derivative I think is what they are adjusting for. Note that the company doesnt really care about the value of the swap as this is just a book loss and is really just trying to lock in a known cash flow. However, if it wants to terminate the swap then it must pay for that loss which is what is being reflected as the higher liability.
Thanks for the response. That makes sense, but shouldn't an interest rate swap reduce variable rate liability and create a separate fixed rate liability then? Does it make sense to include an interest swap on a variable rate liability when in effect it is not variable at all?
 

bklynboy

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Thanks for the response. That makes sense, but shouldn't an interest rate swap reduce variable rate liability and create a separate fixed rate liability then? Does it make sense to include an interest swap on a variable rate liability when in effect it is not variable at all?
My guess is this is being accounted for as a hedge and permits the netting of the swap against the variable note. Derivative accounting can be quite complex but generally if you can demonstrate that this qualifies for hedge accounting then you report the variable note liability net of the swap. If it does not qualify then you report the items separately as you assume would be done.

Note that the variable liability doesnt change as this is what is contractually owed to the holders of the note. What has changed is that the cash flows are swapped with a counterparty. So the variable liability doesnt change in of itself but can be netted with the value of the swap if its a hedge.
 

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