Mark-to-M🍷arket Accounting vs🎶. Historical Cost Accounting: an Overview

Accounting☂ principles are rules that companies must follow when they report their financial data. These guidelines ensure that the data reported is complete, consistent, and accurate. Mark-to-market and historical accounting are two different accounting principles used to determine the value of assets. Mark-to-market measures the current market value of the asset ඣwhile the historical cost accounting principle measures the value of the original cost of an asset.

Mark-to-Market Accounting

The mark-to-market method of accounting records the current or market price of an asset or a 澳洲幸运5官方开奖结果体彩网:liability on financial statements. It is also called 澳洲幸运5官方开奖结果体彩网:fair value accounting because it determines the true value of assets and liabilities, which can fluctuate over time. Marketable securities, commodities, and ac🌠counts receivable (AR) are reported using this accounting method.

As such, companies use mark-to-market accounting to report their assets and liabilities at the estimated amount of money they would receive if they sold the assets or if their liabilities were paid off in the market today. By using contemporary and market-based measurements, mark-to-market accounting aims to make financial accounting information more updated and reflective of current real ma♔rket values.

Mark-to-market accounting can be done in:

• 澳洲幸运5官方开奖结果体彩网:Financial services to account for adjustments in asset accounts
• Personal accounting to deal with changes in the value of a personal asset from when it was originally purchased
• Investing to determine the current value of a financial security or 澳洲幸运5官方开奖结果体彩网:portfolio

Problems with Mark-to-Market Accounting

This accounting🦄 method can be problematic, especially when market prices fluctuate abruptly. It can make profits look higher, which is sometimes prefer💮red if managerial bonuses are based on profit numbers.

This occurred during the 澳洲幸运5官方开奖结果体彩网:subprime mortgage meltdown that led to 澳洲幸运5官方开奖结果体彩网:the Great Recession and years of depressed real estate prices. In the years before the 澳洲幸运5官方开奖结果体彩网:financial crisis, companies and banks were using mark-to-market accountin𝓀g, which caused an increase in performance metr♋ics for companies.

As companies' asset prices rose due to the boom in the housing market, the gains calculated were realized as 澳洲幸运5官方开奖结果体彩网:net income. However, when the crisis hit, there was a rapid decline in the prices of properties. Suddenly, all of the appraisals of their worth were detrimentally off, and mark-to-market accounting was to blame.

Example

Let's say Company ABC bought multiple properties in New York 100 years ago for $50,000. They're now 澳洲幸运5官方开奖结果体彩网:appraised at a market value of $50 million. If the company uses mark-to-market accounting principles, then the cost of the properties recorded on the balance sheet rises to $50 million to more accurately reflect their value in today's market.

Historical Cost Accounting

Historical cost accounting is an accounting method in which the assets listed on a company's 澳洲幸运5官方开奖结果体彩网:financial statements are recorded based on the price at which they were originally purchased. This method is a basic accounting principle outlined by 澳洲幸运5官方开奖结果体彩网:generally accepted accounting principꦐle𒁃s (GAAP) in the U.S. This method is generally used for fixed ass𝐆ets and inventory.

Under GAAP, the historical cost principle accounts for the assets on a company's balance sheet based on the amount of capital spent to buy them. This method is based on a company's past transactions and is a conservative, easy-to-calculate, and reliable method.

Companies tend to use this method of accounting for different reasons. It allows them to be consistent, which makes auditing much easier. Historical cost also prevents the overvaluation of assets, especially during times of high 澳洲幸运5官方开奖结果体彩网:volatility.

Problems with Historical Cost Accounting

The historical cost of an asset is not always accurate and isn't necessarily relevant in future reporting periods. That's because not all assets are held at historical costs. For instance, if a company purchased a building several decades ago, the contemporary market value of the building could be worth a lot more (or less) than the balance sheet indicates. Similarly, 澳洲幸运5官方开奖结果体彩网:marketable securities aren't held at their historical values. I🦹nstead, they are recorded a🎀ccording to their current market value.

Example

Company ABC bought multiple properties in New York 100 years ago for $50,000. Now, 100 years later, a real estate 澳洲幸运5官方开奖结果体彩网:appraiser inspects all of the properties and concludes that the☂ir expected market value is $50꧅ million.

If the company uses historical accounting principles, then the cost of the properties recorded on the 澳洲幸运5官方开奖结果体彩网:balance sheet remains at $50,000. Many might feel that the properties🔯' worth 🐭in particular, and the company's assets in general, are not accurately reflected in the books. Due to this discrepancy, some accountants record assets on a mark-to-market basis when reporting financial statements.

Special Considerations

The right accounting method to use becomes more complicated when determining the different aspects of an asset, such as 澳洲幸运5官方开奖结果体彩网:depreciation and 澳洲幸运5官方开奖结果体彩网:impairment. Historical cost is the standard when recording 澳洲幸♍运5官方开奖结果体彩网:property, plant, and equipment (PP🔯&E) on financial statements. Mark-to-market is dependent 💟on a larger set of factors, such as demand, supply, perishability, and duration of asset holding by the company.

Depreciation is always calculated based on historical cost whereas imp♚airments are alway𝐆s calculated on mark-to-market. Physical assets are more often recorded at historical cost whereas marketable securities are recorded at mark-to-market.

Key Differences

The Bottom Line

There are several accounting methods that companies can employ to report their assets and liabilities. The mark-to-market method is meant to determine the current or fair market value if the asset or liability is sold today while the historical cost method uses the original purchase price. Both are meant for certain assets—the historical cost method accounts for fixed assets under GAAP and often includes inventory. Keep in mind that these methods aren't always reliable and often take economic conditions into account. It's always a good idea to read any disclosures and financial statement footnotes that a company may have.