Old rules: derivative contracts: basic rules pre FA 2004: mark to market
Mark to market (MTM)
This guidance applies to periods of account beginning before 1 January 2005
Most companies that use a mark to market (MTM) basis of accounting for derivative contracts will be trading in derivative instruments, or using them to hedge assets which themselves are marked to market.
To be treated as authorised for the purposes of the derivative contracts rules, a MTM basis must satisfy the general conditions in FA02/SCH26/PARA17(2) (see CFM84010). These general conditions include proper provision for allocating payments under a derivative contract to accounting periods. Where MTM is used, this means that payments must be allocated to the periods in which they become due and payable - this is specified in FA02/SCH26/PARA17(4).
Mark to market accounting is also known as fair value accounting because the company’s balance sheet shows derivative contracts (and other contracts) at their fair value. There is a definition of fair value in FA02/SCH26/PARA17(6). It is the amount that the company would receive from, or have to pay to, an independent person if that person took over all of the company’s rights and liabilities under the contract. This supposes an arm’s length exchange motivated by normal business considerations. Any profits or losses due to any change in value will normally be taken to the profit and loss account.
If a future or option is quoted on a recognised exchange, its market value on any day will be relatively easily ascertained. Valuing over-the-counter contracts is more difficult, and the company may have to use complex mathematical techniques. Normally the value which a company places on a derivative contract in its accounts will equate to a fair value within the statutory definition. If, exceptionally, HMRC staff need to check the valuation of a derivative contract, they should seek advice from CAR Shares and Assets Valuation.
For an example of accounting under the MTM basis for a forward/future contract or an option - see CFM84070.