Question

3.Refer to FNM's last publically reported Balance Sheet before it was placed into Conservatorship:

FNM Balance Sheet (000 UON)	Accrual
PERIOD ENDING 6/30/08	Accounting
Total Current Assets	62,485,000
Mortgages	774,145,000
Property Plant and Equipment	5,995,000
Other Assets	22,689,000
Deferred Tax Assets	20,604,000
Total Assets	885,918,000
Current Liabilities
Accounts Payable	6,309,000
Short/Current Long Term Debt	240,666,000
Total Current Liabilities	246,975,000
Long Term Debt	577,432,000
Other Liabilities	20,285,000
Total Liabilities	844,692,000
Total Stockholder Equity	41,226,000
Total Liabilities + Equity	885,918,000

If you believed that FNM's mortgage assets, as reported, were inflated by 70,000,000K, what journal entries would you use to correct this error? Choose all the correct entries.

a) dr Mortgage Write Down Expense 70,000,000

b) dr Short/Current Long Term Debt 70,000,000

c) cr Cash 70,000,000

d) cr Total Assets 70,000,000

e) dr Mortgages 70,000,000

f) cr Mortgage Write Down Expense 70,000,000

g) cr Mortgages 70,000,000

4.Refer to the information provided in Question 3 above. After you have corrected the value of FNM's mortgage assets, what is the value of the firm's equity?  

Answer 1

Since the value of the mortgage asset is inflated so we have to reduce it. All the assets have normal balance as debit and to reduce it we have to credit them. For example, if we want to reduce the value of an equipment then we have to credit it. So mortgage assets will be credited by the inflated amount.

Answer: g

The reduction in the value of the mortgage assets has to be booked as an expense or an adjustment. Such expense or adjustment will be charged from the retained earnings which is a part of equity. So equity will also get reduced by the amount of reduction made to the mortgage assets. But in this question the value of stockholders’ equity is less than the amount of reduction made to mortgage assets. This means that the reduction is adjusted from mortgage payable which comes under long term debt. So the value of the long-term debt will be impacted and the value of equity will remain the same.

Entry:

Long Term Debt 70,000,000

            Mortgages 70,000,000

Firm's equity = $41,226,000