Mark to Market

Financial Dictionary -> General Finance -> Mark to Market

Mark to market (MTM) is also known as fair value accounting. This term refers to a standardized method of accounting, which represents an accounting act serving to record the value of a securities or a portfolio in order to reflect their current market value, not book value. It is a method that provides for realistic appraisal of the financial situation of an institution or a company at the time of appraisal.

From the beginning of the 90's fair value accounting has been part of US GAAP. Mark to market may give ground to potential for accounting fraud inn cases that the market price could not be objectively recorded via a regulated financial market with day-to-day market prices. Alternatively, there may be no way to review the last couple of sale prices for a certain commodity. One famous example for record fraud is the Enron case. The company became the first US non-financial company to employ MTM accounting for its complex long-term contracts. But the nature of MTM presupposes that the income for long term signed contracts will be estimated as the present value of the net future cash flows. It was often the case that viability of the contracts and their related costs were hard to judge. Due to the discrepancies of expected profit and cash, investors were typically misled. However, despite the drawbacks of the MTM, the US Securities and Exchange Commission (SEC) gave green light to the method. Its introduction led to paradoxes such as the 20-year contract between Enron and Blockbuster Video, signed in July 2000. The scope of contract included the introduction of on-demand entertainment in various cities in US. Eventually, Blockbuster pulled out from the agreement while Enron accounted future profits. Due to this accounting practice, Enron marked great profits in accordance with Wall Street's prognosis. They had no actual future coverage, however.

During the credit crunch of 2008/2009, many financial instruments on the banks balance sheets could not be estimated efficiently because the markets collapsed. Therefore, the application of MTM would inevitably result in a much-lower-than-the-actual value of the banks' assets. As a future countermeasure, the Financial Accounting Standards Board (FASB) voted in April 2009 in favor of new guidelines on the fair value accounting. The organization pronounced that the valuation would be based on prices established in a regulated market rather than on a forced liquidation. The changes are effective as of the first quarter of 2009. Further information and definitions on Mark to Market may be found in Statements of Financial Accounting Standards No. 157, Fair Value Measurements, from the list of FASB pronouncements. A good starting point for reference on taxation rules for mark to market accounting is the Internal Revenue Code Section 475.