Mark To Market Accounting: Definition, Importance and Examples

Mark to market (MTM) is an accounting practice that involves assigning a value to an asset based on its current market prices. This method of accounting aims to provide a realistic valuation of assets and liabilities compared to other accounting frameworks like historical cost accounting, which is based on the asset’s original purchase price. Understanding mark to market and how it works is key for companies and investors to make informed financial decisions.

• Table of contents

1. Defining mark to market (MTM)
2. Why is mark to market accounting important?
3. Mark to market accounting examples
4. Mark to market in accounting standards
5. Mark to market in financial services
6. Mark to market in personal accounting
7. Mark to market in investing
8. Benefits of mark to market accounting
9. Risks of mark to market accounting
10. Mark to market accounting alternatives

Defining mark to market (MTM)

Mark to market or fair value accounting refers to accounting for the value of an asset or liability based on its current market price instead of its historical cost. For example, a stock bought at Rs. 50 that is now trading at Rs. 80 would be marked to market at Rs. 80 on the balance sheet.
The mark to market aims to provide a realistic picture of the fair or market value of assets and liabilities during accounting periods. This helps represent the true present financial condition of a company, as opposed to alternative frameworks like historical cost accounting, which records assets at their original purchase price.

Why is mark to market accounting important?

• Reflects current values: MTM provides a real-time snapshot of asset values as per latest market valuations. This helps represent the true financial position.
• Tracks market volatility: Assets often change in value. Marking to market accounts for fluctuations in the market and shows profits/losses accordingly.
• Provides investor transparency: Marking to market gives investors more insight into a company's current financial health.
• Helps risk management: By tracking current valuations, MTM helps identify overvalued or undervalued assets to facilitate better portfolio management.
• Facilitates comparison: MTM reporting allows for comparison between companies/assets using current values.

Mark to market accounting examples

• Stocks and mutual funds : Publicly traded equities are marked to market daily based on their stock exchange price. So, a scheme’s NAV depends upon the market value of its securities.
• Bonds : Marketable bonds, especially those traded in the secondary market, are adjusted for changes in interest rates and demand.
• Asset-backed securities: Securitised loans and receivables are valued at current market levels.
• Commodities: Inventory including precious metals and raw materials are valued at spot prices.
• Private company investments: Venture capital and private equity holdings get revalued during funding rounds.

These examples reflect how MTM aims to represent financial position based on the most recent valuations across various asset classes.

Mark to market in accounting standards

Mark to market is recognised under various accounting standards.

• Fair value accounting: MTM aligns with fair value accounting under IFRS 13 guidelines.
• US GAAP: Marking to market is permitted under ASC 820 and ASC 825 under US GAAP.
• IND AS: India's IND AS 113 allows fair value accounting similar to IFRS 13 norms.

While allowed, MTM is not mandatory for certain assets under these standards. Companies exercise judgment depending on relevance. But markets and regulators increasingly prefer MTM reporting for transparency.

Mark to market in financial services

Marking to market is widely used in the financial services sector. Key applications include the below.

• Investment funds: Asset management firms mark their portfolios to market daily to track value.
• Banks: Many financial instruments held by banks like derivatives are marked to market regularly.
• Insurers: Insurance companies may mark some assets to market like equity/debt investments.
• Brokerages: Securities in trading accounts are marked to market daily to track investor holdings.

Regular marking to market across the financial sector provides up-to-date financial positioning for reporting and risk management.

Mark to market in personal accounting

• Home valuation: Getting periodic appraisals to mark real estate to market values.
• Car valuation: Checking car valuations on online platforms to mark down current values.
• Marketable securities: Marking investments like stocks, mutual funds to market prices regularly.
• Collectibles: Getting collectibles like art, antiques valued at current market rates.

While individual accounting doesn't require mandatory MTM, it allows tracking personal net worth more realistically.

Mark to market in investing

Marking to market is widely used in investing contexts.

• Mutual fund NAVs: Net Asset Values of mutual fund schemes are marked to market daily.
• Exchange-traded funds: ETFs are marked to market throughout the day based on share prices.
• Brokerage accounts: Positions in trading accounts are valued at market prices daily.
• Institutional investors: Portfolio managers mark holdings to market frequently to assess performance.
• Alternative investments: Assets like private equity or real estate may be periodically marked to market.

Frequent marking to market presents a clear picture of portfolio performance for investment management.

Benefits of mark to market accounting

• Realistic valuation: MTM presents true current asset values rather than outdated historical costs.
• Relevant information: Marking to market provides investors and management more useful insights into the financial position.
• Market discipline: Requires companies to follow diligent valuation methods aligned with the market.
• Risk identification: Helps identify over/undervalued assets and bubbles forming in the markets.
• Performance clarity: Marking to market gives a clear picture of gains/losses for reporting purposes.
• Consistency: Provides a consistent framework for asset valuation across firms and sectors.

Risks of mark to market accounting

• Subjective estimates: Valuation may involve subjective judgments in the absence of market prices.
• Market volatility: Could inflate losses/gains due to temporary market fluctuations.
• Complex standards: Complex for companies to interpret MTM standards for consistent compliance.
• Resource intensive: Requires significant resources for firms to accurately value all applicable assets.
• Procyclicality: May exaggerate economic booms and downturns by recognising unrealized gains/losses.
• Tax implications: Could lead to tax liabilities if assets are marked up even before sale.

Mark to market accounting alternatives

• Historical cost method: Values assets at original purchase cost and ignores market fluctuations.
• Amortised cost: Gradually allocates costs of assets over their useful life.
• Lower of cost or market: Assets are recorded at historical cost but adjusted downwards if the market value drops below cost.

Each method has merits and demerits. Companies adopt alternatives where marking to market is difficult or yields counterintuitive results. But MTM remains preferred for relevance.

Conclusion

Marking to market aims to provide reliable information on the current fair values of assets and liabilities. Despite limitations, MTM offers advantages of real-time valuation, performance clarity, market discipline, investor transparency, and risk management. MTM principles apply across accounting standards, financial services firms, personal accounting, and investing. While complexities exist in valuation, mark to market accounting remains an important practice in the world of finance, particularly investing.

FAQs:

What is Mark to Market (MTM) in accounting?

Mark to market (MTM) or fair value accounting refers to the practice of assigning a value to an asset or liability based on its current market value or price rather than its historical cost. This aims to represent a realistic present-day valuation as compared to historical cost accounting.

Are all assets marked to market?

No, marking to market may not apply to all asset classes. It is commonly applied to liquid securities with readily available market prices like stocks and bonds. But other assets like fixed assets, intangibles, or advances may be excluded from MTM requirements, as estimating fair value can be difficult or yield counterintuitive results in such cases.

What are mark-to-market losses?

Mark-to-market losses refer to declines in valuation of assets when accounted for at their present market value. For example, if a stock held in a portfolio was bought at Rs.100 and is now trading at Rs. 80, marking it to market would result in recognising a Rs. 20 loss per share on the books. However, the loss remains unrealised until the stock is actually sold, at which point it may have recovered or gained in value.

What are the benefits of mark-to-market valuation?

Marking assets to market values offers benefits like real-time insights into financial position, investor transparency, performance measurement, risk management, market discipline, and consistency in valuation. However, MTM also has limitations like subjectivity, volatility, complexity, and tax implications.

How does mark-to-market work in investing?

For investing purposes like mutual funds, securities are typically marked to market at the end of each business day. This involves valuing portfolio holdings at current market prices each day to track net asset value (NAV) and periodic returns.

Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.