Antipathy Towards Mark-to-Market Accounting is Misguided

The antipathy towards mark-to-market accounting is misguided.

Mark-to-market is entirely appropriate for goods that trade in liquid markets. Open up your brokerage statement. If you see a notation that your account gained or lost X% of value, that is an application of mark-to-market. The securities you own did not change. The only thing that changed is the value at which identical securities were traded at the end of each period.

 

Mark-to-market accounting is widely used to mark the value of liquid financial instruments, such as stocks, bonds, and all forms of commodities that trade on exchanges.

 

The virtue of it is in providing an accurate picture of the actual change in wealth of the owner of these liquid securities. If you need to sell your securities, the price you will receive is not your cost- basis; it is the price at which identical securities are trading today, or something close to it, depending on how rapidly you must sell.

In contrast, cost-based accounting for liquid, traded securities is misleading; mark-to-market accounting provides the more accurate picture. If you called your broker to ask him how your account has done during this market meltdown, you would call him a cheat or a fool if he said not to worry because the stocks are worth what you paid for them. That would be an instance of applying cost-based accounting, which is entirely inappropriate for liquid securities.

 

Enron got into trouble by applying mark-to-market accounting to illiquid markets. A notorious example was when Enron used mark- to-market accounting to count as profits the present value of a 20- year agreement to sell telecommunications bandwidth to Blockbuster for the transmission of movies.

 

I am not an accountant, but I use accounting statements professionally in analyzing stocks. Accounting is a highly contextual discipline. The appropriate method depends on what is being accounted and for what purpose. Above all, accounting requires honesty. A crook can always cook the books, and he can do it just as easily using mark-to-market, accrual, cash-based, or cost-based accounting.

 

The government should issue no rules regarding mark-to-market accounting. These should be private decisions made by accountants, investors, and their representative organizations, such as the stock exchanges. Already, by dictating many accounting methods the SEC just makes financial statements harder to understand, which keeps stock analysts, lawyers, and accountants very busy, and creates a fertile field of complexity for future Andy Fastows [1] to walk through.

[1] Andrew Fastow was the CFO of Enron. He is currently serving a six-year prison sentence.

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