Lesson 53 - Intermediate Accounting Course 

53. Understanding Mark-to-Market Accounting and Its Impact

Mark-to-market (MTM) accounting is a method used to record the fair value of assets and liabilities on financial statements. This approach ensures that financial instruments reflect their current market price rather than their original purchase price. While this method provides real-time financial accuracy, it can also lead to significant volatility in a company’s financial performance.

1️⃣ What Is Mark-to-Market Accounting?

Mark-to-market accounting updates the value of an asset or liability based on its current market price. If no active market price is available, companies use valuation models to estimate fair value.

Under IFRS and GAAP, mark-to-market accounting is required for many financial instruments, such as:

✅ Stocks and bonds
✅ Derivatives (futures, options, swaps)
✅ Mutual funds and ETFs
✅ Some categories of loans and receivables

This method contrasts with historical cost accounting, which records assets at their original purchase price regardless of market changes.

2️⃣ How Mark-to-Market Accounting Works

Example 1: Stocks and Securities

A company holds 100 shares of a stock purchased at $50 per share. If the market price rises to $70 per share, the value on the balance sheet is updated:

Investment in Stock       $7,000  

      Unrealized Gain           $2,000  

(100 shares × $70 = $7,000; previous value was $5,000)

If the stock price drops to $40 per share, the company would record an unrealized loss instead.

Example 2: Derivatives and Trading Securities

A company holds a futures contract for oil at $80 per barrel. If the market price drops to $75 per barrel, the contract loses value, and the company must adjust its books to reflect the loss.

Example 3: Loans and Credit Risk

Banks use mark-to-market accounting for loans and credit instruments. If borrowers’ creditworthiness declines, banks adjust the loan values, impacting reported profits.

3️⃣ Benefits of Mark-to-Market Accounting

✅ Accurate Financial Reporting – Reflects real-time asset and liability values.
✅ Transparency for Investors – Provides clearer insights into a company's financial health.
✅ Regulatory Compliance – Required for many financial instruments under IFRS & GAAP.

4️⃣ Risks and Challenges

❌ Market Volatility – Frequent price changes can lead to large fluctuations in financial statements.
❌ Liquidity Issues – If an asset has no active market, estimating fair value can be subjective.
❌ Procyclicality – During economic downturns, asset devaluations can lead to financial instability.

A key example is the 2008 financial crisis, where banks were forced to mark down mortgage-backed securities, worsening the economic collapse.

5️⃣ Mark-to-Market vs. Historical Cost Accounting 

6️⃣ Key Takeaways

✔ Mark-to-market accounting ensures financial statements reflect real-time values.
✔ It is essential for financial assets but can increase earnings volatility.
✔ It played a major role in the 2008 financial crisis due to rapid devaluation of assets.
✔ Not all assets are marked to market—some remain at historical cost.