CFM22210 - Accounting for corporate finance: UK GAAP before 1 January 2005: lenders: mark to market: accounting and the profit and loss account

Profit and loss account

Any changes in market value are taken to the profit and loss account as part of the results for the year. As the justification for adopting mark to market is that the loans are actively traded, the profit and loss heading adopted is often ‘trading results’ or similar wording. This is not the only possibility however. The loan may also be paying interest and this interest may be disclosed separately as interest receivable or included within the changes in market value.

In calculating a market value, the ‘market’ will estimate expected future cash flows. The expected future cash flows will be discounted to reflect such factors as

• current market rates of interest
• the liquidity of the loan
• the creditworthiness of the borrower.

This last factor means that potential doubtful debts, general and specific, are incorporated into the market value rather than identified separately.

In most cases the loan will also include accrued interest. If this accrued interest is included in the market value this is called a dirty valuation, if the accrued interest is excluded then the valuation is a clean valuation.

Mark to market: clean/dirty valuation

A clean mark to market valuation means that the accrued interest is accounted for separately. If the accrued interest is included within the valuation this is a dirty mark to market.

For example, a fixed rate loan of £100m paying 5% annually will be £5m higher on a dirty basis as compared to a clean basis immediately before an interest payment date. But if the loan is stated on a clean basis, the accounts will separately include the £5m as accrued interest receivable. The clean and dirty bases will show the same profit for the period.

Immediately after a payment date the clean and dirty bases give the same valuation.