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Answer: The application of normal accounting rules to hedging transactions can increase the volatility of reported earnings.
A is correct. Under normal accounting rules the volatility in reported earnings can increase, opposite of what would be expected with hedging activity. This is because the gain or loss on the hedges is reported every year rather than in the period when the gain or loss on the instrument being hedged is being reported as in hedge accounting.
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A finance executive at a firm involved in commodity production is studying the accounting principles relevant to hedging practices. The executive aims to understand the impact and application of standard accounting versus hedge accounting, as well as the associated tax consequences of these hedging activities. Which of the following statements correctly describes the appropriate accounting treatment for transactions that involve hedging?
A
The application of normal accounting rules to hedging transactions can increase the volatility of reported earnings.
B
Hedging transactions are generally treated the same for both tax and accounting purposes.
C
Under hedge accounting, the entire gain or loss on a hedge is realized at the same time as the item being hedged.
D
The only requirement for a company to be able to use hedge accounting is that this practice be disclosed on its financial statements.
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