Definition of Mark to Market Accounting
Mark to market accounting is the accounting practice in which all the assets and securities are valued at market price rather than historical cost focusing more on presenting the true and fair view based on current practices, and accordingly, earnings of the company may change due to change in the values.
Mark to market accounting is the system in which a company used to measure the assets and investments at market value rather than historical cost. The market value is calculated on the basis that what will be the value of an asset if the asset is sold at the current date or at the balance sheet date. In the case of mutual fund securities or short-term securities, the securities are valued at market price.
Some of the items measuring on fair value are part of Generally Accepted Accounting Principles in the United States. In mark to market accounting, the value changes as per changes in market conditions. It is volatile in nature. Mark to market condition is the opposite of the historical cost method, which is as per the framework of the law.
History of Mark to Market Accounting
In the 1800s in the US, it was the general practice to record the assets and other securities at the mark to market price, but this has contributed to recession and depression, which results into the collapse of major banks and bankruptcy situations. The Securities and Exchange Commission requested the president to remove the valuation on the mark to market basis, and the president approved it in 1938.
This re-began in 1980 and again resulted in scandals in 1990. Gradually the practice of measuring on a mark to the market basis given to the dealers trading in the securities market so that they can deposit the shortage of the security deposit amount. This becomes the rule that only short term securities and the security dealers, brokers, derivative dealers can follow the mark to market accounting concept.
How Does It Work?
The brokers or persons dealing in the future have to pay some security deposit to the exchange. The reason behind valuation on the mark to market basis is to revalue the investment to the current market value and re-calculate the deposit. If the deposit is short fall, then the trader has to deposit the remaining amount, and if the deposit is in excess, then it will be held to the exchange only till the securities are sold. Some exchanges follow the practice of valuing on the mark to market basis twice a day so that the traders can re-calculate the deposits twice and adjust the same with the price fluctuations.
Example of Mark to Market Accounting
Shares are purchased at $ 10,000 on 1st April 2017 by Mr. X, and on 31st December 2018, the value of shares becomes $ 8,000. Assuming that the shares are available for sale hence the accounting entry will be:
|Loss of securities available for sale A/c Dr||2,000|
|To Investment available for sale A/c||2,000|
|(being loss due to change in market value recorded)|
Now, if at the next accounting year ended on 31st December 2019 the value becomes $ 11,000, then the accounting entry will be as follows:
|Investment on securities available for Sales A/c Dr||3,000|
|To gain on securities available for sales A/c||1,000|
|To Loss on Securities available for sales A/c||2,000|
|(Being change in the value of investment recorded)|
The previous loss first is to be settled from the current gain in order to reflect the true and correct position in the accounts.
Difference between Mark to Market Accounting and Historical Cost Accounting
The following are the major points to be considered as the difference between mark to market accounts and historical value accounts:
- In mark to market accounts, the assets are valued at the current market price, i.e. the value receivable if it is sold on the balance sheet’s date. And the value in mark to market accounting can change from year to year based on the market conditions, and the valuation is volatile in nature, whereas in the Historical cost accounting method, the assets are to be valued at cost plus all related cost for bringing the asset to the present location like storage cost, fare, carriage inwards, etc. and assets are subject to depreciation at every year-end. But the original value remains constant and will not be subject to change unless permitted by law.
- The general practice of accounting says that only security traders and the short term security dealer are allowed to value on the mark to market basis, and that too only for the short term securities and securities of volatile nature, whereas all the assets except the short term investments are to be valued at the historical cost.
Following are the different advantages of mark to market accounting:
- The assets are valued at the current market price; hence the true worth is reflected.
- The investor can measure the loss or gain on the valuation of assets and can record it in the accounts.
- The method of valuation on the mark to market basis is suitable for short term securities and investments.
- It is the recognized method of valuation by most of the security exchange boards.
Following are disadvantages of mark to market accounting:
- The Valuation is volatile in nature.
- As the value can change at every balance sheet date, there are high chances of huge loss or gains that can influence the investor, but the loss or gain is imaginary until the securities are actually sold.
- This valuation method leads to frauds and recession in some of the countries.
- The method is not acceptable by many of countries due to its volatile nature.
Mark to market accounting is the method in which the assets are valued at the current market price, which might reflect the true worth of the company or organization. But the valuation being volatile in nature can influence the investor at a higher level. Hence the method is not acceptable by many of the countries. However, some of the countries permitted to value the short term investment on a mark to market basis, which is a fair valuation.
This is a guide to Mark to Market Accounting. Here we also discuss the definition and history of mark to market accounting along with advantages and disadvantages. You may also have a look at the following articles to learn more –
- Accounting Profit vs Economic Profit
- Accounting Ethics
- Accounting for Fair Value Hedges
- Income Tax Accounting