Tuesday, April 15, 2008

Sentimental accounting: Is it time to question mark-to-market values?

Mark-to-market accounting was thought of to give assets a value that is current and relevant. But when experts differ widely on valuation, does the subjective assessment have much relevance?

The sub-prime crisis has put questions before a number of institutions and instruments — securitisation, rating agencies, mortgage origination process, etc. Questions also need to be raised about something that became a part of the world of complex accounting rules — fair value accounting, or what in popular parlance is called mark-to-market (MTM) accounting.

The MTM rule is not an age-old accounting convention; rather, it is an exception to the age-old accounting rule called historical cost convention. Several bankruptcies in the 1995-1998 period — from the collapse of Barings Bank in 1995 to the big-time failure of Long Term Capital Management — drew a consensus among accounting standard setters that historical cost is not the most relevant information for users of financial statements as they would be interested to know the current value of the assets of the entity.

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