How should you record a loan entry in your business accounts?

Business loans are fundamental for companies. They can be sourced from banks, credit unions or financial institutions, with repayment terms varying from short- to long-term.
Key terms

Beginner bookkeepers will find lots of resources explaining key term definitions online.

The loan process:

Application and approval

Companies submit financials, business plans and fund usage details. The lender assesses their creditworthiness.

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Loan disbursement

Approved funds are provided and the borrower repays based on agreed terms, including interest rates.

Recording loan entries

1. Receipt of loan: record the initial loan receipt with a debit to the bank account and a credit to the loan account (a liability).

2. Interest payments: record interest expense associated with repayments. This involves debiting the interest expense account and crediting the loan liability account.

3. Accrued interest: at each period’s end, adjust the loan liability for accrued unpaid interest. Create a journal entry debiting the interest expense account and crediting the loan liability account.

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Recording journal entries

1. Direct entry: manually create a journal and post it to the general ledger.

2. Bank transaction: use accounting software to record transactions.

3. Invoicing: issue or receive an invoice for loans, posted to the loan account and either accounts payable or accounts receivable.

Loan accounting example

Company A takes a £50,000 loan for five years with 500 monthly payments. Initial entries:

Bank loan received

Debit bank account: £50,000
Credit loan liability: £50,000

Monthly principal payment

Debit interest expense: (monthly interest amount)
Debit loan liability account: £500.00
Credit bank account: £500.00

Monthly interest payment

Debit interest expense: £50.00
Credit loan account: £50.00

Calculating loan interest

Interest expense = loan principal x interest rate x repayment period
For example, a £50,000 loan at 6% interest for five years = £50,000 x 0.06 x five years = £15,000

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Company A pays £15,000 in total interest over the loan term.

Accurate accounting of business loans ensures financial transparency and compliance with standards. Understanding loan terms and efficiently using accounting software aids in effective loan management.

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