Mark to Market AccountingDefined along with its different uses, advantages & disadvantages and more

Written By:
Lisa Borga

What Is Mark to Market (MTM)?

Mark to market accounting is a method of accounting in which accounts whose value may change over time, which includes certain assets or liabilities, are valued based on their current price.

This method of accounting is also called fair value accounting.

It is intended to give a realistic appraisal of the current financial situation of an institution or company based on prevailing market conditions.

This method of accounting is also used for some securities, such as mutual funds, swaps, or securities, in order to indicate their current market value.

Use in Accounting

When the mark-to-market accounting method is used, the value of an asset is adjusted to show its value based on current market conditions.

The market value is arrived at by determining what a business would obtain for selling the asset at that point.

When the fiscal year ends, the balance sheet for the company needs to show the current value for some accounts.

In contrast, other accounts will still reflect historical costs, meaning the assets’ original purchase price.

Use in Financial Services

Some companies that are part of the financial services industry might require adjustments to their asset accounts if they have borrowers that have defaulted on loans sometime during the year.

Once the loans involved have been identified as being bad debt, the company that lent the money must mark down these assets to reflect their fair value by using a contra asset account.

The allowance for bad debts account is often used for this purpose.

Another instance in which a company may use mark to market accounting is when a company offers its customers discounts in an attempt to speed up collections of accounts receivables.

In this case, the company will need to mark down the value of its accounts receivables by using a contra asset account.

The company would need to debit accounts receivable and credit sales revenue for the full amount of the sale.

After this, they would need to estimate the percentage of customers they believe will use the discount and then debit the contra revenue account, sales discount, and credit the contra asset account, allowance for sales discount.

Use in Personal Accounting

When individuals use mark to market accounting for their personal accounting, the market value is used in the same way replacement cost is used for an asset.

This is useful since the replacement cost of items is often different than the original cost, also known as the historical cost of an item.

Use in Investing

When used in securities trading, mark to market consists of recording the value or price of a portfolio, account, or security so as to indicate the current market value instead of the book value.

This is common for futures accounts to make certain that investors meet margin requirements. If the current market value of the securities in a margin account drop below the required level, the investor will face a margin call.

Additionally, mutual funds are marked to market every day when the market closes to give investors a more accurate idea of the value of the net asset value of the fund.

Examples of Fair Accounting Uses

Here are two examples of the use of fair value accounting.

Example One

One of the more common examples of mark to market accounting is available for sale securities.

These are debt or equity securities that an investor buys but intends to sell before the securities reach maturity.

For those securities that don’t have a maturity date, the investor intends to sell the securities sooner than they would normally be sold.

The gain or loss of market value for these available for sale securities is reported as part of the account other comprehensive income located in the balance sheet’s equity section.

Example Two

Held-for-trading assets are another common example of fair value accounting.

These assets are debt or equity investments that are purchased by investors who intend to sell them for short-term gain.

The asset is typically kept for less than a year.

The gains and losses that occur due to changes in the market value of assets that are classified as available for trading are reported on the income statement as unrealized losses or gains.

How to Calculate Mark to Market

Here are the steps for calculating mark to market.

• Determine the settlement Price: There are different steps that might need to be taken to determine the settlement price for different assets. But, in most cases, it will be necessary to average some traded prices that occurred during the day. Generally, this will involve averaging the last few transactions for the day. However, this will not include the closing price since this price is sometimes manipulated by traders. Calculating the average price can help to reduce the effect of any manipulation.
• Realizing any loss or profit: This step will depend on the average price that is used as the settlement price as well as any contract price that was previously agreed to.

Example of Mark to Market Computations

Suppose two parties enter into a futures contract for 5,000 bushels of soybeans for $16 per bushel with a 6-month maturity period.

This means the value of the security is $80,000 ($16.00 * 5,000). However, the price per bushel was $16.50 by the end of the next trading day.

This means a trader in a long position would receive $2,500 [($16.50 – $16.00) * 5,000] from a trader that was in a short position for that specific day.

This gain would be recorded as other comprehensive income in the equity section on the balance sheet, and it would also increase the asset, marketable securities, by the amount of the gain.

Had there been a loss, it would be recorded on the income statement as an unrealized loss.

Additionally, marketable securities would need to be decreased by the amount of the loss.

Advantages & Disadvantages of Mark-to-Market Accounting

Advantages of Mark-to-Market Accounting

Here are some of the advantages of Fair Value or mark to market accounting.

• It is useful for helping to mitigate risk. This is due to the fact that having a more accurate idea of how much an investment is worth can help an investor to make better investment decisions.
• It can allow banks to more easily confirm the value of any collateral for a loan.
• This method of accounting can help to produce a more accurate valuation of the assets a company possesses. This can be useful if a company is trying to obtain financing or if the company is liquidating some assets.

Disadvantages of Mark-to-Market Accounting

Fair value accounting has several advantages, but there are some disadvantages to consider as well.

• If the market is volatile or trending toward a downturn, it may be harder to estimate the value of a company’s assets by using this method.
• This method is not always accurate. The fair market value is obtained by considering what the company expects someone would pay for their asset. However, this does not mean someone would necessarily pay that amount if the asset were actually sold.
• With this method, companies might devalue their assets during a downturn without adequate consideration.

Final Thoughts

Mark to market is a way of valuing securities at the current market price.

It is a very useful concept for investors to understand, especially those who are involved in futures trading.

It can be useful for helping investors to meet margin requirements and for determining the amount of money they have made or lost in a day’s trading.

Key Takeaways

• Mark to market may provide investors with more accurate information about the current value of the assets a company owns because it is based on the amount a company might obtain for the asset in current market conditions.
• Fair value accounting is different than historical cost accounting, which keeps the value of an asset at its cost when it was purchased.
• Mark to market may not give an accurate reflection of the value of an asset during volatile or difficult times.