Mark to market accounting is a business practice in which the value of assets is assessed in terms of what those assets would hold if they were sold on the open market, rather than their “book value.” Assets such as securities, futures contracts, and loans can all be valued with the use of mark to market accounting, and this tactic has both advantages and disadvantages which should be carefully considered. As with other accounting practices, once someone starts using mark to market accounting, he or she is obligated to do so for the rest of time, unless special permission is received from a tax agency. In some cases, people are actually required to use this accounting practice.
The roots of mark to market accounting lie in the futures trading market, which started in the 1800s. Futures traders buy and sell contracts for things which have not actually happened yet, such as the spring crop harvest. The “book value” of the asset would be the contractually-agreed price at the time of sale. When the asset is marked to market, however, it would be valued on the basis of what would happen if it was sold immediately on the open market.
Depending on the state of the market, mark to market accounting can create a situation in which someone appears to have more money than he or she really does, or less. The same holds true for companies which use mark to market accounting. The advantage of mark to market accounting is that people can post a gain or loss without actually incurring the gain or loss, which can be used to reduce a tax burden, or to promote a company to investors.
The disadvantage of this practice is that it assumes that the current market reflects fair value for an asset. In fact, this may not always be the case. A company may buy securities at a high price, for example, and hang on to them through a low period when they appear to decline in value, only to sell them at a higher price even later.
In the economic crisis which occurred in 2008, several economists suggested that mark to market accounting was playing a major role. As banks were forced to write down assets such as mortgage-backed securities and loans, their “value” appeared to decline in the eyes of investors, creating a panic. Had mark to market accounting practices not been used, some economists felt that failing banks might have survived, because they would not have been forced to dramatically write down their value in quarterly reports.