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.
Generally Accepted Accounting Principles require companies to record certain assets at their current value, not historical cost. The practice of recording these values using mathematical calculations is referred to as mark-to-model. This process was developed so assets 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. The mark-to-model process applies to Level 2 assets, which may not be actively traded; however, it’s possible to interpolate or extrapolate their worth based on the value of similar securities.
The mark-to-model approach is criticized for its reliance on assumptions and subjective assessments. It’s also associated with the credit crisis of 2007, which involved the write down of billions of dollars of mortgage assets based on assumptions that were later found to be inaccurate. In early 2009, the Financial Accounting Standards Board (FASB) would approve guidelines that allowed for values to be based on an orderly market, not a forced liquidation.