How to Book a Loan Payment

Sometimes it’s the little things about keeping the books that can drive you nuts, like how exactly to book a loan payment. I hope I can be a resource for you in your day to day dilemmas!

Here’s a question from a reader last week:

I have a loan showing as a liability on my balance sheet. Do I bill it to pay it ,so it shows as an expense to the company?

Because liabilities (loans) have a positive credit balance, in order to reduce it you’ll need to debit that account. The offsetting credit will be to [reduce] cash. However, most loans come with interest. While repayment of loan principal itself is not an expense, interest is. To book the entry you should debit an interest expense account, offsetting with a credit to cash.

All together it looks like this:

Debit to Loan Liability $principal
Debit to Interest Expense $interest
     Credit to Cash $payment amount

If you have been booking interest payable (credit balance), then you’ll debit that instead of expense.

Why Isn’t a Loan Repayment of Loan Principal an Expense?

The loan itself is not an expense, but some of the things you finance with those funds are. When money comes into the company in the form of a Loan/Liability, Cash is increased (debited), and a loan is created (credited). When that cash is spent, Cash is reduced (credited) and an expense is increased (debited). Unless of course the Cash is spend on an Asset, in which case you debit the Asset and expense it over time through Depreciation.

I hope that answers your question. Keep ‘em coming!

Image Credit: tj scenes, Flickr