Week 4 - Mark to Market Accounting

Question 1

What is Mark to Mark accounting?

Answer 1

MTM requires that companies record SOME securities at their fair value (current market price). Previously all securities were recorded at their amortized cost (also known as historical/book value minus depreciation).

Question 2

What three categories does MTM accounting divide asset side securities into?

Answer 2

1) Investment Securities
2) Available for Sale Securities
3) Trading Securities

Question 3

Could the same security be categorized differently for two different businesses under the MTM system?

Answer 3

Yes, MTM security classification depends on both the security and the business holding the security.

Question 4

What is an investment security?

Answer 4

A security intended to be held to maturity. In other words they are only used to collect income generated, not to be sold for capital gain.

Question 5

At what price is an investment security recorded under the MTM accounting system?

Answer 5

At amortized cost (historical value minus depreciation) as it will not be sold so any change in market price is irrelevant.

Question 6

What is a trading security?

Answer 6

Trading securities are purchased with the intention of reselling for capital gain.

Question 7

At what price is a trading security recorded under the MTM accounting system?

Answer 7

At fair value since they could be sold at any time.

Question 8

What is an available for sale security?

Answer 8

A security held with the intention to be sold. They are distinct from trading securities insofar as they are not intended to be sold for capital gain but may be sold for liquidity purposes. They are held as a substitute for money (as money doesn’t earn interest).

Question 9

At what price is an available for sale security recorded under the MTM accounting system?

Answer 9

At fair value since it could be sold at any time.

Question 10

Can securities change categories under the MTM system?

Answer 10

Yes, HTM can become AFS or TS and AFS can become TS. However, neither AFS nor TS may become HTM.

Question 11

What component of equity is adjusted to reflect changes in market value of trading securities?

Answer 11

Retained profits are adjusted as changes in market value for trading securities are recorded as an income/

Question 12

What component of equity is adjusted to reflect changes in market value of available for sale securities?

Answer 12

Because it is not certain that AFS securities will be sold, the capital reserve component of equity adjusts to reflect a change in value without a change in profit.

Question 13

Describe the balance sheet for a change in market value of AFS securities when no sale occurs.

Answer 13

Assets (AFS) increase by change in price

Equity (Cap reserve component) increase by change in price

Question 14

Describe the balance sheet for a change in market value of TS when no sale occurs

Answer 14

Assets (TS) increase by change in price

Equity (Retained Profit) increase by change in price

Question 15

Describe the balance sheet for a change in market value of HTM securities and a sale occurs at the end of the period.

Answer 15

Assets (ESFs) increase by sale price
Assets (HTM) decrease by original purchase price
Equity (Retained Profits) change by difference between sale price and purchase price.

Question 16

Describe the balance sheet for a change in market value of TS and a sale occurs at the beginning of the period.

Answer 16

Assets (ESFs) increase by sale price
Assets (TS) decrease by sale price

NOTE: No change in Equity (retained profits) as this is recorded throughout the life of the security.

Question 17

Describe the balance sheet for a change in market value of TS and a sale occurs at the end of the period.

Answer 17

Assets (ESFs) increase by sale price
Assets (TS) decrease by price from start of period

Equity (retained profit) increase by difference between above

Question 18

Describe the balance sheet for a change in market value of AFS securities when a sale occurs at the beginning of the period.

Answer 18

Throughout the life of the security, unrealized cap gains have been recorded as a change in equity under the capital reserve component. Therefore, first, this reserve must be transferred to the retained profits:

Equity (Capital Reserve Component) Decreases by Sale price less purchase price
Equity (Retained Profits) Increases by the same

Then the Asset is converted to ESFs
Asset (ESF) increase by sale price
Asset (AFS) decrease by sale price

Question 19

Describe the balance sheet for a change in market value of AFS securities when a sale occurs at the end of the period.

Answer 19

Throughout the life of the security, unrealized cap gains have been recorded as a change in equity under the capital reserve component. Therefore, first, this reserve must be transferred to the retained profits. There is also a net change in equity equal to the change in price over the period:

Equity (Capital Reserve Component) Decreases by Price at start of period less purchase price
Equity (Retained Profits) Increases by the sale price less purchase price

Then the Asset is converted to ESFs
Asset (ESF) increase by sale price
Asset (AFS) decrease by price at period beginning as this is the price it is recorded at still.

Question 20

What are some examples of trading securities? (4)

Answer 20

Interest bearing investments in short term securities such as:
Treasury Notes
Commercial Papers
Certificates of Deposit 
Commercial bills

Question 21

What are some examples of investment securities? (3)

Answer 21

Longer term interest bearing securities such as:
Treasury Bonds
Domestic Corporate Bonds
Eurobonds