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Answer: The application of normal accounting rules to hedging transactions can increase the volatility of reported earnings.
**Explanation:** 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. B is incorrect. Many jurisdictions, the US in particular, treat hedging transactions differently for tax and accounting purposes. C is incorrect. Under hedge accounting, the entire gain or loss on a hedge is realized at the same time as the item being hedged. D is incorrect. There are very strict rules regarding whether a company can use hedge accounting, including that any hedge be fully documented and be effective, with an economic relationship not dominated by the effect of credit risk.
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A financial officer at a commodity producing company is researching accounting rules related to hedging activities. The manager compares the application and impact of using either normal or hedge accounting as well as the tax treatment of hedging activities. Which statement is correct regarding the given type of accounting treatment for hedging transactions?
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 in the year it occurs.
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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