How do we record a loan payment correctly?
From my experience, a loan payment is often categorized incorrectly.
Once you understand it though, it is pretty simple. Unless you were able to borrow the money without interest (how nice!), you always want to make sure to categorize the interest portion to expense.
What if done wrong?
If done wrong, your balance sheet and P&L are incorrect! The loan payable balance is probably incorrect, and so is the profit on the P&L.
The interest expense is a deduction and reduces your taxes, so another reason we want to make sure it is done correctly.
Here is how you can categorize it correctly.
You can obtain the amount from the statement or online.
If you use QuickBooks Online, you can split the payment in the bank feed.
If you have more than one loan, you want to make sure to categorize it to the account where this specific loan balance is recorded.
We want to reduce the loan payable balance only by the remaining amount of the payment (= principal) because when you receive a loan, you should have recorded the amount to the loan payment balance, which represents only the principal.
It is a very easy step yet we don’t want to miss it. It is just a check to confirm you did it correctly.
If you are categorizing the loan payment using a journal entry:
ex) You paid $600, $100 interest with $500 principal
Dr. Interest expense $100
Dr. Loan payable $500
Cr. Cash $600
How to record it is the same regardless of who you borrowed money from. Even if you borrow money from your family and friends for the business, you make sure to record the interest paid to the interest expense account.
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