Journal Entry for Interest Expense on Loan
A loan is the amount of cash that a company borrows from a bank or other financial institution. A loan may be used for a variety of purposes, including working capital, equipment purchases, fixed assets, or expansion business.
The terms of a loan are typically outlined in a contract, which includes the repayment schedule, interest rate, collateral, and so on. Loans are typically repaid over a period of time, with interest accruing on the outstanding balance. Given the potential risks and rewards associated with borrowing, loans should be carefully considered before entering into any agreement.
When a company borrows loans, they need to pay interest to the lender. Interest is usually charged as a percentage of the loan amount, expressed as an annual rate. The interest rate typically reflects the cost of borrowing money and is determined by many factors such as the risk involved with offering a loan, the creditworthiness of the borrower, and market conditions.
Larger companies with strong financial standing are able to secure lower interest rates than smaller companies with weaker financial situations. Additionally, loans may also include other fees and charges aside from just interest payments.
Any business that takes out a loan has the responsibility to pay back that loan according to the terms of their agreement. This includes not only the original loan amount but also any interest that has accrued.
Failure to repay a loan can have serious consequences, including damage to one’s credit score and legal action from the lender. For this reason, it is essential that businesses take their repayment obligations seriously and work to ensure that they are able to meet their financial obligations. By doing so, they can avoid potential problems down the road and keep their business on solid footing.
Journal Entry
Interest Expense is recorded based on the accrual basic which is not related to the cash payment. It depends on the loan principle, interest rate, and time coverage.
At the end of the accounting period, company has to calculate the interest expense based on the above factors. After that, they have to record interest expense and interest payable.
| Account | Debit | Credit |
|---|---|---|
| Interest Expense | $$$ | |
| Interest Payable | $$$ |
When the company makes a payment, they need to remove interest payable and decrease the cash balance.
| Account | Debit | Credit |
|---|---|---|
| Interest Payable | $$$ | |
| Cash | $$$ |
Example
Company ABC has borrowed the cash amount $ 50,000 from the bank to expand the operation. The loan is provided with an interest rate of 12% per year. The company is required to pay the interest expense on the monthly basis.
At the end of the month, company has record interest expenses. And the payment is made after two days.
Please prepare journal entry for interest expense and payment.
At the end of the month, company has to calculate the interest expense.
Interest expense = ($ 50,000 x 12%)/12 months = $ 5,000 per month
After the calculation, the company needs to record interest expense on the income statement. The journal entry is debiting interest expense $ 5,000 and crediting interest payable $ 5,000.
| Account | Debit | Credit |
|---|---|---|
| Interest Expense | 5,000 | |
| Interest Payable | 5,000 |
When the company makes a payment to bank, they need to reverse the interest payable $ 5,000 and credit cash $ 5,000.
| Account | Debit | Credit |
|---|---|---|
| Interest Payable | 5,000 | |
| Cash | 5,000 |
Difference Between Interest Payable and Interest Expense
Interest expense is the amount of interest incurred by a company during a certain period of time. Interest expense is charged against the company’s earnings and reduces its profitability. It is the expense incurred by a company when they take out a loan or borrow money. It is the cost associated with borrowing money and is paid to the lender in exchange for the loan of funds.
Interest payable, on the other hand, is an account payable item that shows how much interest has been accrued but not yet paid. After incurring interest expense, companies will also record a liability for the amount owed for that period of interest expense in their balance sheet as “interest payable”.
This accrued but unpaid amount will be paid at some future date and appears as a current liability. The company has the obligation to settle the interest with bank or creditors.