We have heard many times about Marked to Market(MTM) as an accounting term but do you know that this term is something we usually describe in the accounting language. So lets discuss what is mark to market?
So What is Mark to Market?
Mark to Market refers to an accounting method where fair values of assets and liabilities are determined during a period of time. In short, it is nothing but a fair value accounting of an entity’s resources. The goal is to provide an insight about the entity’s current financial situation.
But Why Mark to Market?
Usually companies follow the Historical method of accounting but MTM represent the more accurate representation of the assets of the company. This is because MTM represents the actual value the asset would fetch if sold in the open market.
Industries where Mark to Market is usually used?
MTM accounting can be followed by any industry but usually financial services industry follow MTM accounting. This include banks, mutual funds, brokerage houses, etc. This is adopted in order to depict the current and fair value of investments such as futures, loans, indices, Exchange traded funds and mutual funds.
Purpose of Mark to Market accounting
The basic purpose of MTM is to reflect the correct picture of assets or liabilities in the financials. For a financial services industry like banks and others, they need to make adjustments to the loan in an event the borrower defaults in loan repayment. These loans are further classified as NPA and a corresponding effect is been given in financials as Bad debts/provision of bad debts.
Example 1-Similarly a discount given by an entity to debtors, for early payment of dues, will have to adjust its Accounts Receivables and a contra asset account has to be created for the effect.
Example 2 -A securities trading company always follow MTM accounting for its trading transactions. This is done to measure the current value of securities. In case the current value of securities increases and it requires to increase the margin amount , then such amount has to be deposited.
Example 3 – For Mutual funds, the funds/unit are also accounted on Mark to Market basis daily to arrive at the NAV of the unit and an investor gets to know his return on investment.
Practical Problem – What is Mark to Market?
Suppose an investor holds a short position for 10000 contracts of Rice. Each contract comprises of 100 kg. Each contract value is Rs. 10. So the amount to be debited to investor is Rs. 100,000( 10000*10)
Now if the price of the wheat contract falls then it will be a gain to the investor. Similarly if the price decreases then it will be a loss to the investor
On Day 1, the contract price drops to Rs. 9, then investor will gain Rs.10000 (1 *10000). If in the day 2, the price increases to Rs. 9.25, then the investor account would be debited by Rs. 250 (10000*0.25) (Rs9.25-Rs. 9).
This holds inversely for the person who holds a long position.
Is Mark to Market method always useful ?
Though Mark to Market method reflects the true value of an asset, it is not always useful especially during volatile and recession times.
When the assets are required to be sold off during crisis times, then the asset sale value might not reflect its true value. This happens for assets who have low liquidity or the market is cash starved.
For e.g during 2008-09 many entities who were on the verge of closure were required to disclose assets at their existing sales value the asset would fetch. This created huge losses to the entities as the sale value during crisis time were much lower than the sale value in orderly market times.
So this I would like to conclude my article on What is Mark to Market accounting? Hope you found the article interesting and informative. Let me know your comments and I would request to like this topic and share it with your friends through social media.
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