Mark-to-market accounting has advantages and disadvantages. While I agree with s
ID: 2424978 • Letter: M
Question
Mark-to-market accounting has advantages and disadvantages. While I agree with some comments the author makes, such as "mark-to-market accounting may feed bubbles as well as causing a downward spiral in financial markets in crisis", I disagree when the author states "mark-to-market accounting reflects the true values in the balance sheet of financial institutions and is therefore more informative for investors about true value and risk profile of institution".
Under mark-to-market accounting rules, expected earnings are harder to calculate because an investor cannot tell if gains and losses are due to yield shocks or cash flow shocks, causing the investor to be unaware of the true value. FASB has also attempted to lower, with mark-to-market accounting, the number of companies that "manage" earnings by choosing what and when to sell assets. However, even under mark-to-market accounting, companies can still window dress since markets are not totally liquid.
The theory behind mark-to-market accounting makes perfect sense, but all the information that investors use for determining valuation is not included.
http://www.bloombergview.com/articles/2012-05-02/mark-to-market-accounts-signal-caution-for-investors
Comment
Explanation / Answer
Mark - to - market accounting is a way of valuing assets based on how much they could sell for under currnt market conditions. Mark - to - market diferes from historical cost accounting which looks back to the assets original purchase price to determine its valuaiton.
Mark - to market accounting, of course refllect the true values in the balance sheet, but these market values are not permancent, frequently changes, so, the balance sheet, sometimes may be overstated and someties may be under stated. Overstatement and understatement of assets and liabilites are due to flucitons in market vlaues of assets and liabilities.
Sometimes, it is is very difficult to get the market vlues of assets and liabilites due to absence of developement of organised capital market. sometimes,investors also may not know the information regarding market price. FASB accepts to record assets and liabilites at market value or fair vlaue in some instances. In case any loss of impairment of assets, that loss has to be accounted for.
It is better, to record the assets and liabilites at historical cost, where the market value is not available and the change is not permanent, then Balance sheet is not windowdressed rather it reflects correct value of the asset if we account for depreciaiton or apprecaiton of the asset.
Finally , assets and liabilities have to be shown at their Historical cost after adjusting to the deprecaitona and apprecaition in the value of an asset, but, this may seriously distort the fianncial statements of banks as their assets are tend ot change due to fluctuaitons in market price. Hence, mark - to - market accounting is to be adopted in some casses and historical cost to be adopted in some other cases where the change is temporarily. But in marke to market accounting, investors evidence huge book profits when stock prices increase and losses when stock prices decrease. So, which type of accounting is to be adopted in case of debt and equity instruments depends upon the purpsoe of holding whether it is " hold to maturity" or 'hold to trading'