The importance of mark to market accounting

Posted On: 06 March 2025

Mark to market (MTM) is an accounting practice that involves assigning a value to an asset based on its current market prices. This method of accounting aims to provide a realistic valuation of assets and liabilities compared to other accounting frameworks like historical cost accounting, which is based on the asset’s original purchase price. Understanding mark to market and how it works is key for companies and investors to make informed financial decisions.

Table of contents

Defining mark to market (MTM)
How does mark to market work?
How to calculate mark to market value?
Why is mark to market accounting important?
Mark to market accounting examples
Industry applications of mark to market accounting
Mark to market in accounting standards
Mark to market in financial services
Mark to market in personal accounting
Mark to market in investing
Mark to market in futures and derivatives
Benefits of mark to market accounting
Risks of mark to market accounting
Common misconceptions about mark to market accounting
Mark to market accounting alternatives
Mark to market vs historical cost accounting

Defining mark to market (MTM)

Mark to market or fair value accounting refers to accounting for the value of an asset or liability based on its current market price instead of its historical cost. For example, a stock bought at Rs. 50 that is now trading at Rs. 80 would be marked to market at Rs. 80 on the balance sheet.
The mark to market aims to provide a realistic picture of the fair or market value of assets and liabilities during accounting periods. This helps represent the true present financial condition of a company, as opposed to alternative frameworks like historical cost accounting, which records assets at their original purchase price.

How does mark to market work?

The core principle of MTM is to reflect the current market value of an instrument. If market prices rise, the value of the asset increases; if prices fall, the value declines. These changes are recorded even if the instrument has not been sold. This helps present a more current picture of portfolio valuation, though it also introduces short-term fluctuations.

In practice, MTM works as follows:

The latest available market price of a security is used for valuation.
If a traded price is unavailable, valuation may be based on approved valuation models or matrix pricing.
Gains or losses arising from price movements are recorded as unrealized until the asset is sold.

How to calculate mark to market value?

The basic calculation involves identifying the latest observable price and applying it to the quantity held. The difference between the current value and the earlier recorded value represents the MTM gain or loss. Importantly, this gain or loss remains unrealized until the instrument is actually sold.

The general steps involved are:

Identify the quantity of the instrument held.
Determine the latest available market price from a recognised exchange or approved valuation source.
Multiply the quantity by the current market price to arrive at the MTM value.
Compare this value with the previous valuation or acquisition cost to compute the MTM impact.

Why is mark to market accounting important?

Reflects current values: MTM provides a real-time snapshot of asset values as per latest market valuations. This helps represent the true financial position.
Tracks market volatility: Assets often change in value. Marking to market accounts for fluctuations in the market and shows profits/losses accordingly.
Provides investor transparency: Marking to market gives investors more insight into a company's current financial health.
Helps risk management: By tracking current valuations, MTM helps identify overvalued or undervalued assets to facilitate better portfolio management.
Facilitates comparison: MTM reporting allows for comparison between companies/assets using current values.

Mark to market accounting examples

Stocks and mutual funds : Publicly traded equities are marked to market daily based on their stock exchange price. So, a scheme’s NAV depends upon the market value of its securities.
Bonds : Marketable bonds, especially those traded in the secondary market, are adjusted for changes in interest rates and demand.
Asset-backed securities: Securitised loans and receivables are valued at current market levels.
Commodities: Inventory including precious metals and raw materials are valued at spot prices.
Private company investments: Venture capital and private equity holdings get revalued during funding rounds.

These examples reflect how MTM aims to represent financial position based on the most recent valuations across various asset classes.

Industry applications of mark to market accounting

Key industry applications include:

Banking and financial services: Banks apply MTM to certain categories of financial instruments, such as trading portfolios, government securities, and derivatives. Instruments classified as held for trading or fair value categories are revalued based on market prices at prescribed intervals, with valuation changes impacting the profit and loss account, as per regulatory and accounting norms.
Mutual funds and asset management: Mutual fund portfolios are valued using MTM on a daily basis to compute the net asset value (NAV), in line with SEBI valuation guidelines.
Insurance companies: Insurance companies apply MTM to specific investment assets, particularly those linked to unit-linked insurance products (ULIPs) and other market-linked portfolios, subject to regulatory and accounting requirements.
Commodity and energy companies: Firms involved in commodities, oil, gas, or power trading apply MTM to exchange-traded futures and certain forward or derivative contracts, reflecting changes in market prices.
Corporate treasury operations: Companies with derivatives or foreign currency exposures apply MTM to eligible financial instruments to assess currency, interest rate, or market risk, in accordance with applicable accounting standards.

Mark to market in accounting standards

Mark to market is recognised under various accounting standards.

Fair value accounting: MTM aligns with fair value accounting under IFRS 13 guidelines.
US GAAP: Marking to market is permitted under ASC 820 and ASC 825 under US GAAP.
IND AS: India's IND AS 113 allows fair value accounting similar to IFRS 13 norms.

While allowed, MTM is not mandatory for certain assets under these standards. Companies exercise judgment depending on relevance. But markets and regulators increasingly prefer MTM reporting for transparency.

Mark to market in financial services

Marking to market is widely used in the financial services sector. Key applications include the below.

Investment funds: Asset management firms mark their portfolios to market daily to track value.
Banks: Many financial instruments held by banks like derivatives are marked to market regularly.
Insurers: Insurance companies may mark some assets to market like equity/debt investments.
Brokerages: Securities in trading accounts are marked to market daily to track investor holdings.

Regular marking to market across the financial sector provides up-to-date financial positioning for reporting and risk management.

Mark to market in personal accounting

Home valuation: Getting periodic appraisals to mark real estate to market values.
Car valuation: Checking car valuations on online platforms to mark down current values.
Marketable securities: Marking investments like stocks, mutual funds to market prices regularly.
Collectibles: Getting collectibles like art, antiques valued at current market rates.

While individual accounting doesn't require mandatory MTM, it allows tracking personal net worth more realistically.

Mark to market in investing

Marking to market is widely used in investing contexts.

Mutual fund NAVs: Net Asset Values of mutual fund schemes are marked to market daily.
Exchange-traded funds: ETFs are marked to market throughout the day based on share prices.
Brokerage accounts: Positions in trading accounts are valued at market prices daily.
Institutional investors: Portfolio managers mark holdings to market frequently to assess performance.
Alternative investments: Assets like private equity or real estate may be periodically marked to market.

Frequent marking to market presents a clear picture of portfolio performance for investment management.

Mark to market in futures and derivatives

In futures contracts, MTM works by comparing the contract price with the daily settlement price determined by the exchange. The difference is credited or debited to the trader’s margin account. This daily settlement mechanism is designed to limit the build-up of unrealised losses and supports the management of counterparty risk within the clearing system.

The MTM process in futures and derivatives typically involves:

Daily revaluation of open positions based on the exchange’s settlement price.
Credit of MTM gains or debit of MTM losses to the margin account.
Requirement to maintain prescribed margin levels if MTM losses reduce the available balance.
Ongoing monitoring of positions until they are squared off or the contract expires.

MTM in futures and derivatives reflects short-term price movements and prevailing liquidity conditions. It does not represent realised outcomes unless positions are closed. As a result, MTM can lead to frequent changes in margin balances, highlighting the higher risk and leverage characteristics associated with futures and derivatives trading.

Benefits of mark to market accounting

Realistic valuation: MTM presents true current asset values rather than outdated historical costs.
Relevant information: Marking to market provides investors and management more useful insights into the financial position.
Market discipline: Requires companies to follow diligent valuation methods aligned with the market.
Risk identification: Helps identify over/undervalued assets and bubbles forming in the markets.
Performance clarity: Marking to market gives a clear picture of gains/losses for reporting purposes.
Consistency: Provides a consistent framework for asset valuation across firms and sectors.

Risks of mark to market accounting

Subjective estimates: Valuation may involve subjective judgments in the absence of market prices.
Market volatility: Could inflate losses/gains due to temporary market fluctuations.
Complex standards: Complex for companies to interpret MTM standards for consistent compliance.
Resource intensive: Requires significant resources for firms to accurately value all applicable assets.
Procyclicality: May exaggerate economic booms and downturns by recognising unrealized gains/losses.
Tax implications: Could lead to tax liabilities if assets are marked up even before sale.

Common misconceptions about mark to market accounting

Here are some common misconceptions investors may have about MTM accounting:

MTM losses mean actual financial losses: MTM losses reflect a decline in the current market value of an asset at a specific point in time. They are unrealized and do not translate into an actual loss unless the asset is sold or the position is closed.
MTM gains guarantee returns: An increase in MTM value indicates a higher current valuation, not assured future outcomes. Market prices may move unfavourably after the valuation date, affecting eventual results.
MTM applies only during market volatility: MTM is applied consistently, regardless of whether markets are calm or volatile. Valuations change daily even during relatively steady market phases.

Mark to market accounting alternatives

Historical cost method: Values assets at original purchase cost and ignores market fluctuations.
Amortised cost: Gradually allocates costs of assets over their useful life.
Lower of cost or market: Assets are recorded at historical cost but adjusted downwards if the market value drops below cost.

Each method has merits and demerits. Companies adopt alternatives where marking to market is difficult or yields counterintuitive results. But MTM remains preferred for relevance.

Mark to market vs historical cost accounting

Under historical cost accounting, assets are recorded at their purchase price and remain on the books at that value, subject to depreciation or amortisation where applicable. This method provides consistency and reduces short-term fluctuations in reported values. However, it may not reflect the current economic value of an asset, especially when market prices change materially over time.

Mark to market accounting, in contrast, revalues assets and liabilities at prevailing market prices at regular intervals. This approach aims to reflect the current fair value as of a specific date. As a result, reported values may fluctuate more frequently, particularly during volatile market phases.

The key differences may be summarised as follows:

Aspect	Mark to Market Accounting	Historical Cost Accounting
Valuation basis	Assets and liabilities are valued using current market prices or approved valuation models.	Assets are recorded at their original purchase price, adjusted for depreciation or amortisation where applicable.
Impact of market movements	Reported values may change in line with prevailing market prices, leading to regular valuation fluctuations.	Short-term market price movements generally do not affect the recorded value.
Frequency of revaluation	Revaluation is carried out on a daily or periodic basis, depending on the nature of the instrument and applicable regulatory or accounting requirements.	Revaluation is typically infrequent and occurs through depreciation, impairment, or disposal.
Transparency of valuation	Aims to provide higher transparency by reflecting current market value at a specific point in time.	Offers consistency in reporting but may not reflect current market conditions.
Effect on reported results	Unrealised gains or losses are recognised, which can lead to higher short-term variability in reported financial results.	Gains or losses are recognised only when the asset is sold or impaired.
Regulatory usage in India	Required for certain instruments, such as mutual fund portfolios, derivatives, and other specified financial instruments.	Commonly used for fixed assets and long-term holdings where market-based valuation is not required or practical under applicable standards.

Conclusion

Marking to market aims to provide reliable information on the current fair values of assets and liabilities. Despite limitations, MTM offers advantages of real-time valuation, performance clarity, market discipline, investor transparency, and risk management. MTM principles apply across accounting standards, financial services firms, personal accounting, and investing. While complexities exist in valuation, mark to market accounting remains an important practice in the world of finance, particularly investing.

FAQs:

What is Mark to Market (MTM) in accounting?

Mark to market (MTM) or fair value accounting refers to the practice of assigning a value to an asset or liability based on its current market value or price rather than its historical cost. This aims to represent a realistic present-day valuation as compared to historical cost accounting.

Are all assets marked to market?

No, marking to market may not apply to all asset classes. It is commonly applied to liquid securities with readily available market prices like stocks and bonds. But other assets like fixed assets, intangibles, or advances may be excluded from MTM requirements, as estimating fair value can be difficult or yield counterintuitive results in such cases.

What are mark-to-market losses?

Mark-to-market losses refer to declines in valuation of assets when accounted for at their present market value. For example, if a stock held in a portfolio was bought at Rs.100 and is now trading at Rs. 80, marking it to market would result in recognising a Rs. 20 loss per share on the books. However, the loss remains unrealised until the stock is actually sold, at which point it may have recovered or gained in value.

What are the benefits of mark-to-market valuation?

Marking assets to market values offers benefits like real-time insights into financial position, investor transparency, performance measurement, risk management, market discipline, and consistency in valuation. However, MTM also has limitations like subjectivity, volatility, complexity, and tax implications.

How does mark-to-market work in investing?

For investing purposes like mutual funds, securities are typically marked to market at the end of each business day. This involves valuing portfolio holdings at current market prices each day to track net asset value (NAV) and periodic returns.

How do companies apply MTM in different industries?

Mark to market practices vary across industries. Financial services value securities at prevailing market prices. Commodity businesses revalue inventories using exchange prices. Derivative-intensive sectors assess contracts daily. Manufacturing applies fair value selectively. The objective remains consistent: reflect current economic value, while disclosures explain assumptions, valuation models, and limitations clearly consistently.

What is the difference between unrealized and realized MTM losses?

Unrealized MTM losses represent notional declines based on current market prices without an actual sale. Realized MTM losses arise when the asset is sold or settled at a lower value. Unrealized losses may reverse with price movements, while realized losses permanently affect reported income and capital.

How does mark to market affect mutual fund NAV calculation?

Mark to market directly influences mutual fund NAV calculations. Portfolio securities are valued at closing market prices each day. Gains or losses, realized or unrealized, flow into NAV. This process ensures transparency, daily valuation accuracy, and comparability across schemes, while reflecting prevailing market conditions in line with SEBI norms consistently.

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