Academic journal article The Journal of Government Financial Management

Mark to Market for Governments

Academic journal article The Journal of Government Financial Management

Mark to Market for Governments

Article excerpt

Years of Crisis

Over the last two years, several factors have coincided to bring scrutiny to the derivative financial instruments environment, particularly how governments account for them. First, questionable practices in the financial services industry with respect to issuing risky and complex derivatives came close to toppling the U.S. economic system. Decisions made by a few individuals had such a worldwide social and economic impact that recovery will take years.

Next, financial firm executives and even congressional leaders were quick to accuse an accounting method, specifically mark to market, as being one of the main causes of the recent crisis. This public outcry forced the Financial Accounting Standards Board (FASB) to loosen some measurement requirements of Statement No. 157, Fair Value Measurements. At the same time, after several years of study and evaluation, the Governmental Accounting Standards Board (GASB) issued Statement No. 53, Accounting and Financial Reporting for Derivative Instruments. Last, GASB has undertaken a research project specifically aimed at refining measurement and reporting issues associated with the measurement of fair value.

This article examines the role of mark to market in government accounting, specifically in the area of derivative instruments. It argues that mark to market, also called fair value accounting, while controversial and not without flaws, is the best way for governments to measure and report the financial activity of derivative instruments. As will be discussed, mark-to-market accounting is congruent with a government's multiple financial reporting objectives of accountability, transparency, consistency, interperiod equity and risk assessment.

Just What is Mark-to-Market Accounting?

Mark-to-market accounting refers to the accounting standards of assigning a value to a position held in a financial instrument based on the current fair market price, rather than its original cost or book value, for the instrument or similar instruments. Fair value has been part of U.S. generally accepted accounting principles (GAAP) since the early 1990s, and investor demand for the use of fair value when estimating the value of assets and liabilities has increased steadily since then as investors desire a more realistic appraisal of an institution's or company's current financial position. Mark to market is a measure of the fair value of accounts that can change over time, such as assets and liabilities. For example, financial instruments traded on a futures exchange, such as commodity contracts, are marked to market on a daily basis at the market close.

Both FASB and GASB have developed definitions of what each calls the fair value of a financial instrument. FASB Statement No. 157 defines fair value as: "The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at measurement date." GASB (Codification section 150.105) defines fair value as: "The amount at which an investment could be exchanged in a current transaction between willing parties other than in a forced or liquidation sale." As you can see, the definitions are quite similar.

What Was (Is) All the Fuss About?

FASB Statement No. 157 took effect in 2007. The statement was an attempt to increase consistency and comparability in fair value measurement and related disclosures, especially for complex and unusual financial instruments, such as credit default swaps and mortgage-backed securities. Statement No. 157 developed a fair value hierarchy that prioritized the inputs (information) used for valuation techniques to measure fair (market) value into three broad levels. These levels are:

Level 1 Inputs: These are quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at measurement date. These inputs have little controversy associated with them, as they are developed primarily from readily available public data. …

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