Mortgage Accounting Rules

Mortgage accounting rules help a lender record and report lending activities in accordance with generally accepted accounting principles (GAAP), industry practices and federal regulations. A lender's mortgage activities affect its financial statements, including its balance sheet--also known as a statement of financial position--income statements, cash flow statements and the statement of retained earnings or equity statement.

U.S. GAAP and international financial reporting standards (IFRS), require a firm to record asset and mortgage values at fair or current values. To illustrate, an investment bank's senior credit officer approves a $1 million mortgage with a 10 percent annual interest rate. The borrower signs mortgage documents and she agrees to repay the loan over a 30-year period. The annual interest payment is $100,000 and it is due on March 15 every year. An accountant at the investment bank debits the mortgage loan receivable account for $1 million and he credits the cash account for the same amount. On March 16 of the following year, the borrower pays $100,000. The accountant credits the interest receivable account for $100,000 and he debits the cash account for the same amount.

In accounting parlance, loan impairment means a lender believes a borrower may be unable to reimburse a loan. This scenario may occur if a borrower files for bankruptcy or experiences significant liquidity problems. After 15 months, the investment bank's credit officer believes the borrower may default on the mortgage and he calculates a recoverability rate of 60 percent. This means that the firm might collect only $600,000 from the borrower on $1 million. The accountant needs to record the $400,000 impairment loss. He debits the mortgage impairment account for $400,000 and he credits the allowance for doubtful items account for the same amount.

U.S. GAAP and IFRS require the investment bank to record mortgage transactions in corporate financial statements at the end of the quarter or year. A senior accounting manager at the firm indicates the mortgage loan receivable amount in the balance sheet's long-term asset category. Short-term assets are resources that a firm can convert into cash, or sell within a year and they include inventories and accounts receivable. The accounting manager then shows the allowance for doubtful accounts in the balance sheet and she subtracts $400,000 from $1 million to get the new loan value of $600,000. She also records the impairment loss in the statement of profit and loss.