A business obtains a principal and interest loan of 500 at an annual interest rate of 6% to be repaid in 3 annual installments of 187.05 at the end of each year.
For this type of loan the cash payments (187.05) are the same each period throughout the term of the loan, and include an amount paid off the principal loan balance (500), and an amount for the interest on the loan for the accounting period.
In order to make the loan repayment journal entries it is necessary to split each of the cash payments into the principal and interest elements as they are posted to different accounts.
Loan Repayment Schedule
The first step is to produce a loan repayment schedule as shown below.
Each line of the table is based on the formula as follows:
If we use year one as an example, the beginning loan principal balance is 500, the interest added to the account is calculated as 500 x 6% = 30, and the loan repayment deducted is 187.05.
As the interest is 30, then the principal repayment is 157.05 (187.05-30.00), and the ending balance of 342.95 represents the outstanding principal balance on the loan.
Loan Repayment Bookkeeping Journals
The following bookkeeping journals are needed to record the interest payment and the principal loan repayment each period.
Year 1 Loan Repayment
The principal loan repayment is 157.05 which is the cash payment of 187.05 less the interest expense of 30.00.
Year 2 Loan Repayment
The principal loan repayment is 166.47 which is the cash payment of 187.05 less the interest expense of 20.58
Year 3 Loan Repayment
The principal loan repayment is 176.46 which is the cash payment of 187.05 less the interest expense of 10.59.
Loan Repayment Journal Entry Explained
In each of these journals there are two debit entries. The debit to the interest expense records the accounting entry for interest on the loan for the year calculated at 6% on the beginning balance. The debit to the loan account records the reduction in principal of the loan balance which is the cash repayment less the interest expense.
accounting entry for interest on loan
Cash has been used to make the the annual loan repayment to the lender on the due date in accordance with the loan agreement.
Accounting Equation – Loan Repayment
The accounting equation, Assets = Liabilities + Owners Equity means that the total assets of the business are always equal to the total liabilities plus the equity of the business This is true at any time and applies to each transaction. For this transaction the accounting equation is shown in the following table.
Using the loan repayment for year 1 as an example.
In this case an asset (cash) decreases as the loan repayment is made to the lender. On the other side of the equation a liability (loan) decreases representing the reduction in the loan principal, and the interest expense reduces the net income, retained earnings, and therefore the owners equity in the business.
Popular Double Entry Bookkeeping Examples
Another double entry bookkeeping example for you to discover.
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