The term mark-to-market is an important phrase in corporate finance that has many nuances and industry-specific uses. Mark-to-market is a corporate finance term that provides businesses with a way to evaluate a holding’s fair value for both assets and liabilities. Since values can change over time, this gives a rational assessment of a business’ present fiscal circumstances based on the latest market climate.
When it comes to securities, an investment that is mark-to-market shows its current value. It’s a way to look at how much a business might get if it sells assets under current market conditions. This measurement is opposed to historical cost accounting, which keeps the asset’s value according to the asset’s price when first purchased.
When a business prepares its balance sheet, some assets will be recorded at their historical cost or original purchase price, while others will need to reflect current market value. One type of asset that needs to be marked down is accounts receivable. If a business permits a 5 percent or 10 percent discount to collect on those to generate cash flow, it needs to reduce that item’s value via an adjustment for doubtful accounts or similar terms.
One important consideration is how mark-to-market is different from impairment. Since retailers or manufacturers store most of their operation’s values in property, plant, and equipment (PPE), along with accounts receivable, such assets are documented at historical cost. If the assets lose value due to obsolescence, theft, damage in transit, a natural disaster, or uncollected accounts receivables, they would be impaired.
When it comes to derivatives that businesses use, mark-to-market assessment may be needed, according to ASC 815-30 for a cash flow hedge or ASC 815-35 for a net investment hedge of a foreign operation. Specifically, whatever is “excluded from the assessment of effectiveness” is attributed to earnings via a mark-to-market procedure or through amortization.
A derivative, according to Accounting Standards Codification (ASC) 815-10-15-83, is a contract that derives its value based on the underlying variable. Examples of underlying variables include commodities, indexes, or the occurrence or nonoccurrence of an event (natural disaster). These types of contracts can be used to hedge or preserve the owner’s ability to buy the underlying at the agreed-upon price, especially if it increases in the future. Other uses include speculating on the movement of stock prices or engineering financing arrangements.
A derivative is defined as a financial instrument or other contract that has all of the following characteristics:
It’s important to factor in periods of high volatility or when there are illiquid markets or few buyers and sellers of investments; what the market prices applicable to investments doesn’t always give a true reflection of an asset’s price. One recent example was when the market for mortgage-backed securities during the 2008-2009 crisis evaporated, the market gave an inaccurate value of the securities.
Businesses that navigate the intricacies of when and how to use mark-to-market assessments are using an important tool to help keep their books in order.