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Are will it be what you feel will make your fairyland look the best!!

Oh, and mark to market isn;t subject to fairytale accounting ?

A few years ago a friend of mine had an experience at an aircraft spare parts trading company that illustrates the limitations of market value accounting. At this company there were many spare parts that had an active bid/ask market and reasonable market values were quickly established without controversy.

However, in one corner of the hanger there were spare nose cones for Boeing 737s. Each nose cone had a historical cost of $10,000. The current market value of each nose cone was less than $1,000 and was equal to its aluminum meltdown value (scrap metals dealers were the only buyers). However, if anywhere in the world a Boeing 737 broke its nose cone; They would sell one of his cones out of inventory, usually for greater than $50,000.

Mark to market accounting would have valued the nose cones at around $1,000 per cone. Before mark to market accounting, $10,000 would have been their carrying value.

The above example illustrates three flaws with mark to market accounting.

* Mark to market accounting uses quick sale valuations which are non-going concern liquidation values for assets and are almost always lower than going concern valuations. However, a core GAAP assumption is that companies are going concerns and violation of that assumption destroys the value of financial statements.

* Valuing nose cones at melt value shifts income from the period of the mark down to the period of the sale (as well as inflates expenses during the period of the markdown). This distorts the income recognition principal that revenues and expenses should be recognized in the period incurred.

* Mark to market accounting distorts management decisions and market prices. The application of mark to market accounting stops management teams from investing in new assets that are subject to subsequent quick sale liquidation analysis. One of the problems in the current credit crisis is “banker refusal” to make loans to companies and consumers because of the risk of an immediate mark down upon origination. In the above nose cone example, if mark to market accounting is used, no spare parts trading company will replenish supply once their nose cones are sold. The application of mark to market accounting to nose cones will drive the market price of cones to $1,000 despite the ultimate realizable value of $50,000. This type of price distortion is currently driving the market for many financial assets.

So, you haven't really escaped fairy tale land accounting by continuing this practice.

* Mark to market accounting distorts management decisions and market prices.

Stop that, when you have accounting that is tailored to management you have no accounting standards. You have an Author Anderson, accounting should be accounting and management, should be management. One reports on the work of the other.

**In the above nose cone example, if mark to market accounting is used, no spare parts trading company will replenish supply once their nose cones are sold.**

Nose Cone 1,000
Gain on sale of Nose Cone 49,000

Don’t know about you but I would replenish. In fact if the company only made nose cones it’s income statement would look much than if they was valued at 10,000.

Excellent commentary, and thank you!

TJ Rogers recently wrote up a little piece on how MTM rules had created a set of financials for Cypress Semiconductor wherein TJ could not even answer an investor’s simple question: How much ‘cash’ do you have *right now*?

When TJ found out that he had to look in at least three different places on the balance sheet to come up with “where the cash went” from the pre-MTM days to the “MTM today” accounting, he was furious.