Financial Accounting and Reporting-CPA Practice Exam

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What is recorded on the income statement for a cash flow hedge?

Gains or losses of both effective and ineffective portions
Only the effective portion of gains and losses
No entries related to cash flow hedges
Gains or losses tracked in comprehensive income only

The correct answer is: Gains or losses of both effective and ineffective portions

The correct choice for what is recorded on the income statement for a cash flow hedge is the option that includes both effective and ineffective portions of gains and losses. In the context of cash flow hedges, the effectiveness of the hedge is assessed continuously, and any changes in the fair value of the hedging instrument must be recognized. For effective cash flow hedges, gains and losses are initially reported in other comprehensive income (OCI) until the hedged transaction affects earnings. However, the ineffective portion of the cash flow hedge is required to be recognized immediately in the income statement. Therefore, the income statement reflects both the changes that have been taken to OCI for the effective portion and the immediate recognition of the ineffective portion, leading to the conclusion that both effective and ineffective portions should be recorded when applicable. This nuanced treatment is essential in understanding the accounting for cash flow hedges, as it ensures that the financial statements represent both the protective nature of the hedges and any potential misalignment in their effectiveness.