Thursday, April 2, 2009

Accounting Rule Change May Improve Asset Valuation

Today the Financial Accounting Standards Board (FASB) relaxed its mark-to-market rule for certain assets. Now companies will be able to use "'significant' judgment" in pricing these assets. However the companies must provide increased information on how they value them.

The mark-to-market rule requires companies to value certain assets at their fair value or market rate--what others are willing to pay for them. However, when no one wants to buy those assets their price falls. The company must then value those assets at the fallen price on their books. This is what happened with mortgage backed securities. When they stopped trading, the entities that held them had to mark down their value on their balance sheets. However FASB now allows businesses to use their own judgment and decide what the assets are worth. The intention is to record these assets at their true value.

But value is based on how much someone is willing to pay for whatever is being valued. If the asset is not priced according to the demand for it, the value may be misleading. Even though a business' balance sheet may look better under this rule, that improvement may be artificial.


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