The Difference Between Mark-To-Market & Historical Cost Accounting

Throughout the course of time, both mark-to-market (which is also called “fair value”) and historical accounting methods have played a significant role in ensuring the financial health of millions of businesses. Whether you’ve heard of them before or have encountered them while working somewhere else, knowing about both historical and mark-to-market accounting can help you put your business ahead.

Unfortunately, most business owners are unable to differentiate between the two, which leads to troublesome results. Mark-to-market and historical accounting are two distinctly different accounting methods that are used to record the price or value of an asset.

To ensure that you don’t mix up your business’s numbers by mistaking one for the other, let’s go over both types of accounting asset value recording methods in greater detail:

What is the historical cost accounting method?

Historical cost accounting is an accounting method wherein the assets that are listed in a company’s financial statements are recorded according to the original price a business bought them for.

In fulfillment of the United States’ generally accepted accounting principles (GAAP), the historical cost accounting principle uses the amount of capital spent on the purchase when accounting for the assets on a given balance sheet. US businesses, more often than not, opt for the historical cost accounting method because it is based on a company’s past transactions— essentially making it reliable, conservative, and easy to compute.

It is worth noting, however, that the historical cost of an asset used in this particular method is not always going to be relevant at a later point in time. For example, if a company purchased a piece of machinery a few decades ago, then its contemporary market value would be much more than what the balance sheet indicates. For example, a piece of equipment that was purchased for $1,000 in 1910 that is worth nearly $20,000 nowadays will still be recorded as $1,000 in the books.

What is the mark-to-market method?

The mark-to-market method of accounting entails recording the current market price of an asset or liability on financial statements. Alternatively known as fair value accounting, the mark-to-market method is an approach that is used by companies in order to properly record or report the value of an asset should they choose to sell it.

Through the use of contemporary measurements, business owners and accountants can make their accounting information more accurate and relevant as a means to gain the proper value on purchases and investments.

As opposed to historical cost accounting, the value of any asset recorded in a balance sheet with the mark-to-market method can fluctuate from period to period based on several external and internal factors in the market. For instance, if a building was bought in 1855 for $2,500 and is worth well over $10,000,000 now, then it will be recorded as $10,000,000 in the purchasing business’s balance sheet.

Knowing the difference between historical cost and mark-to-market accounting is an essential piece of business knowledge that can be used to determine your business’s numbers more accurately. By taking this quick and easy guide on the difference between the two types of accounting in mind, you can set yourself up for a much easier experience when putting your business’s numbers together.

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