How does the fair value option for financial instruments under US GAAP affect earnings?

The fair value option for financial instruments under US GAAP allows entities to measure certain financial instruments at fair value, with changes in fair value recognized in earnings. This mechanism can introduce greater volatility in reported earnings since market conditions can fluctuate, causing significant changes in fair value. As a result, the earnings reported in any given period may reflect substantial gains or losses depending on the movement of the underlying asset prices, interest rates, or other market factors.

This variability is an inherent feature of using fair value measurements because they are often influenced by external market conditions that can change rapidly. Additionally, while the balance sheet reflects the fair value of assets and liabilities, it is the impact on the income statement from fair value adjustments that leads to the volatility in reported earnings. Therefore, the statement that this approach can result in increased volatility of reported earnings is correct and highlights the implications of utilizing the fair value option in financial reporting.