Journal entry for loan payment with interest

Introduction

In business, we may need to get a loan from the bank or other creditors to start our business or to expand our operation. Likewise, when we pay back the loan including both principal and interest, we need to make the journal entry for loan payment with the interest to account for the cash outflow from our business.

As the interest expense is the type of expense that occurs through the passage of time, we usually need to record the accrued interest expense before the payment of the loan and the interest is made. Likewise, the journal entry for loan payment with interest usually has the interest payable account on the debit side instead of interest expense account.

However, sometimes, there is no need for accruing the interest expense on the loan payable. This is usually the case when the interest expense is just an insignificant amount or we only have a short-term loan in which its maturity will end during the accounting period. In this case, we will have the debit of interest expense account in the journal entry for the loan payment instead of the interest payable account.

Of course, we may have both the interest expense account and the interest payable account for the loan payment journal entry when the recorded accrued expense is only for a portion of the interest of the loan for one period. And other portions of interest expenses on loan payable are for other periods.

Journal entry for loan payment with interest

We can make the journal entry for loan payment with interest by debiting the loan payable account and the interest payable account and crediting the cash account.

In this journal entry, the interest has been accrued and the interest expense has already been recorded in the last period-end adjusting entry. This is due to the interest on loan payable is the type of expense that occurs through the passage of time.

However, if the accrued interest has not been recorded for some reason, we need to debit the interest expense account instead.

Likewise, the journal entry for loan payment with interest will be the debit of loan payable and the interest expense account with the credit of cash account as below:

This usually happens when the interest is just an immaterial amount or the loan is a short-term one and ends during the accounting period. Likewise, there is no need to record the accrued interest expense before the payment happens.

Of course, there are also cases that the interest is only accrued for a portion of the full interest amount. In this case, the journal entry for the loan payment with interest will include both the debit of the interest expense and the debit of the interest payable as below:

Example for loan payment with interest

For example, on January 1, 2021, we have borrowed a $20,000 loan from the bank with an interest of 10% per annum. The period of the loan is 12 months in which we need to pay back both the loan principal of $20,000 and the 10% interest which is $2,000 on January 1, 2022.

The ending day of the accounting period of our company is on December 31, in which we need to close all the income statement accounts and transfer the net income to the balance sheet as the retained earnings.

In this case, we can make the journal entry for borrowing a loan of $20,000 from the bank by debiting this amount into the cash account and crediting the same amount to the loan payable account as below:

January 1, 2021:

In this journal entry, both total assets and total liabilities increase by $20,000 as a result of borrowing a $20,000 loan from the bank on January 1, 2021.

Later, on December 31, 2021, we need to make the journal entry for the accrued interest on the loan payable with the amount of $2,000 ($20,000 x 10%) by debiting it to the interest expense account and crediting the same amount to the interest payable account.

December 31, 2021:

This journal entry of the accrued interest on loan payable is necessary to avoid the understatement of the liabilities as well as the understatement of the expenses when we prepare the financial statements at the end of the accounting period. Likewise, without this journal entry, total expenses on the income statement and total liabilities on the balance sheet will be understated by $2,000 as of December 31, 2021.

Then, on January 1, 2022, when we make the loan payment including both principal and interest, we can make the journal entry for the loan payment of $20,000 with the interest of $2,000 as below:

Loan payment with interest on January 1, 2022:

In this journal entry, we do not record the interest expense for the loan payable that we borrowed from the bank. This is because the interest expense on the loan occurred in the 2021 accounting period. And we have already recorded it in 2021 when we make the adjusting entry at the end of the 2021 accounting period.

Example 2:

For example, assuming that we borrow the loan of $20,000 from the bank above on July 1, 2021, instead of January 1, 2021. And we need to pay back the $20,000 loan with the interest of $2,000 on July 1, 2022, instead.

In this case, we can make the journal entry for borrowing the $20,000 money from the bank on July 1, 2021, as below:

July 1, 2021:

Then, on December 31, 2021, which is our period-end adjusting entry, we need to make the journal entry for the accrued interest on the loan payable amounting to $1,000 ($20,000 x 10% x 6/12) as below:

December 31, 2021:

In this journal entry, we record only $1,000 of interest expense to the income statement because the interest expense has only occurred for 6 months as the loan starts at the middle of the year, not at the beginning of the year as in example 1. Likewise, there is only a $1,000 expense that should be recorded in the income statement for the 2021 period.

Later, on July 1, 2022, when we make the loan payment with the interest, we can make the journal entry as below:

July 1, 2022:

The $1,000 of the interest expense in this journal entry is another portion of the interest expense that occur during the 2022 accounting period.