The term mark-to-management refers to an accounting process that records the value of certain assets and liabilities using a combination of market and internal information, not historical cost. Mark-to-management accounting rules are typically applied to Level 3 assets, which are not actively traded or management's judgment is required due to volatility in the market.
Explanation
Generally Accepted Accounting Principles require companies to record certain assets at their current value, not historical cost. The practice of recording these values using a company's subject matter experts is referred to as mark-to-management. This process was developed so assets and liabilities appearing on a company's balance sheet reflected their true value, which can materially differ from historical cost.
Guidance is provided in Statements of Financial Accounting Standards No. 157, Fair Value Measurements, which describes both the fair value hierarchy as well as the disclosure requirements for assets and liabilities not recorded at historical cost. Ideally, a mark-to-market approach is used to value assets. However, if the market for this asset is experiencing volatility, it may be necessary to augment that information with internal expertise. That is to say, the value of the asset should reflect "normal" market conditions to avoid the inappropriate write-down of its value as a result of short-term instability.
The mark-to-management process applies to Level 3 assets, which are traded infrequently and do not have reliable market prices. Examples include holdings such as complex derivatives, securitized cash flow instruments, long-dated options, and private equity investments.
The approach relies on a combination of the company's subject matter experts, historical market prices, as well as complex mathematical models. As is the case with the mark-to-model approach, mark-to-management accounting is criticized for its reliance on assumptions and subjective assessments. The approach is sanctioned by the Financial Accounting Standards Board (FASB), which in 2009 approve guidelines that allowed for values to be based on an orderly market, not a forced liquidation.
Also known as a statement of financial position, the balance sheet is used to show the financial health of a company at a particular point in time. The balance sheet consists of assets, liabilities, and owner's equity in the company. It is one of the four key financial statements issued by public companies.
The financial accounting term Historical Cost Principle refers to a valuation technique used in the preparation of financial statements. The Historical Cost Principle states the value of an asset or liability is recorded on the balance sheet at its cost at the time of acquisition.
The term mark-to-market refers to an accounting process that records the value of certain assets and liabilities at their current market price, not historical cost. Mark-to-market accounting rules are typically applied to actively-traded assets such as stocks, bonds and similar securities.
The term mark-to-model refers to an accounting process that records the value of certain assets and liabilities using a mathematical or financial model, not historical cost. Mark-to-model accounting rules are typically applied to complex financial instruments that are not actively traded.
The term Level 1 asset refers to a hierarchy framework that identifies assets and liabilities possessing the most transparent and tangible values. Companies are required to value certain assets and liabilities at their current value, not historical cost. The hierarchy framework used to value these assets includes three levels, with Level 1 being the easiest to verify.
The term Level 2 asset refers to a hierarchy framework that includes assets and liabilities whose values are based on models and have inputs that are observable. Companies are required to value certain assets and liabilities at their current value, not historical cost. The hierarchy framework used to value these assets includes three levels, with Level 2 requiring the use of a mathematical model.
The term Level 3 asset refers to a hierarchy framework that includes assets and liabilities whose values are based on complex mathematical models and internal inputs. Companies are required to value certain assets and liabilities at their current value, not historical cost. The hierarchy framework used to value these assets includes three levels, with Level 3 requiring mathematical models as well as the expertise of internal subject matter experts.