Final answer:
A firm is considered to be in bankruptcy when the value of its equity is negative, which indicates that the firm's liabilities exceed its assets leading to a financial state where the firm cannot meet its obligations to creditors. The correct option is B.
Step-by-step explanation:
A firm is considered to be bankruptcy when the value of its equity is negative. This financial state occurs when a firm's liabilities exceed its assets. In the context of a balance sheet, this means that the company owes more than what it owns or is owed to by others.
Bankruptcy reflects a situation where the firm cannot meet its financial obligations to creditors and, therefore, may seek legal protection to reorganize or liquidate.
For example, if we look at the case of Freda's and Frank's houses, both have positive equity values, hence they are not bankrupt. Freda's house value is $250,000 with zero liabilities, giving her full equity. Frank owes $60,000 on his house valued at $160,000, indicating $100,000 of equity. However, if the value of the assets fell below the liabilities, the equity value would turn negative, signifying bankruptcy.