Refer to the El Paso Corporation vignette (Theory in Practice 7.2) in Section 7.3.5.

Required

a. As a U.S. corporation, El Paso is subject to U.S. GAAP. Why are unrealized gains and losses on derivative instruments designated as cash flow hedges included in other comprehensive income under SFAS 133?

b. The ceiling test applies to proved reserves of oil and gas companies that use successful efforts accounting (SFAS 144). Explain why effective cash flow hedging of future production can reduce or avoid ceiling test write-downs for oil and gas reserves.

c. Use the “highly effective” criterion for a hedge to evaluate whether EI Paso’s decision that its cash flow hedges of its oil and gas production were not valid was a correct one.

d. Suppose that El Paso did not revise its cash flow hedge accounting. That is, suppose that it continued to designate these hedges as effective cash flow hedges. Suppose also that media reports began to question whether El Paso’s natural gas reserves were correctly stated. Outline some possible consequences for El Paso of this questioning.

e. Do you feel that the management of El Paso, and its auditor, behaved ethically during this episode? Explain why or why not.