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Innovative Mortgage Accounting Method

Lake Larry Trust has developed a new accounting system for their mortgages where interest is automatically calculated and added to the balance of loans with each transaction, whether it is a payment, bill, or default. This increases both revenue from interest and the asset value. However, this technique may not be consistent with standard accounting practices as revenues and assets are increased even when loans are no longer viable, such as in defaults.

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5 views1 page

Innovative Mortgage Accounting Method

Lake Larry Trust has developed a new accounting system for their mortgages where interest is automatically calculated and added to the balance of loans with each transaction, whether it is a payment, bill, or default. This increases both revenue from interest and the asset value. However, this technique may not be consistent with standard accounting practices as revenues and assets are increased even when loans are no longer viable, such as in defaults.

Uploaded by

impurewolf
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Case Study No.

2
Lake Larry Trust is a small bank specialising in mortgages. The Information Technology department
has developed a revolutionary new system of accounting. The idea behind it is actually quite simple.
When a payment, or any transaction, is received, the program automatically calculates the interest
due since the last transaction. The interest is added to the outstanding value of the loan, and the
value of the transaction is applied. So, for example, a payment of $1,000 on a loan $90,000 @ 12%
would apply interest for one month (1%):
Balance 1/1/12 $90,000
Plus interest 900
Sub-Total $90,900
Less Payment (1,000)
New Balance $89,900

However, if a bill, for example for taxes, is received, the balance increases:
Balance 1/1/12 $90,000
Plus interest 900
Sub-Total $90,900
Plus Taxes 1,000
New Balance $91,900

This means that Revenue (interest) is increased with both types of transactions, and assets are also
increased. This is also true when a mortgage which is insured falls into default. The costs of a
foreclosure action are added to the value of the mortgage, and interest continues to accumulate,
resulting in revenues being realised and Assets being increased in spite of the fact that the loan is no
longer a truly viable asset.

Do you think that this accounting technique is actually consistent with accounting practice?

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