A Lawyers' Primer on "Mark-to-Market" Accounting

Many lawyers find the term "mark-to-market" somewhat confusing. "Mark-to-market" refers generically to some accounting other than historical cost accounting. Given the importance of applying fair value accounting, (i.e., "market"), appropriately in today's business climate, and the potential for the recognition of losses -- as well as recoveries -- on investments, a primer in the application in accounting rules is beneficial.

Excerpt

"Mark-to-market" refers generically to some accounting other than historical cost accounting. Traditional accounting standards developed in an industrial environment and called for the use of historical cost for the recognition of assets on a company's balance sheet. Real estate provides the classic example. Whatever the cost of constructing or purchasing a building, even one such as the Empire State Building in 1929, the owner does not change that historical cost of that asset on its balance sheet, regardless of changes in the fair value of the asset in the marketplace, until the owner actually sells it.

However, as the United States economy shifted over time, reflecting the movement from operating fixed assets to financial assets, the Financial Accounting Standards Board (FASB), the governing body who sets generally accepted accounting principles (US GAAP) in the United States, increasingly moved toward the use of "market" for measurement of certain assets on the balance sheet, reflecting unrealized gains and losses, even without a bona fide sale.

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Making appropriate, initial classifications of investments can be critical, because under US GAAP, the investor company cannot readily change investments from one category to another without consequence. (ASC 320-10-35-10). First, to be deemed proper, the standards require some evidentiary support of management's intent with respect to the investment before a classification change. Additionally and critically, reclassification takes place at fair value, i.e. "market." Therefore, classification changes can impact financial results significantly. Nevertheless, the financial crisis and its continuing impact may force management, even reluctantly, to change its initial "intent" with respect to holding certain investments and therefore classification. [footnote omitted]

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