How is a Line of Credit Fee Accounted For
The fees associated with a line of credit (LOC), including the interest expense and any origination or annual fees, are generally considered business expenses for accounting purposes.
Here is how these are typically accounted for:
- Interest Expense: The interest that accrues on the amount drawn from a LOC is recorded as an interest expense in the company’s income statement. This is done typically on an accrual basis, meaning the expense is recognized as it is incurred, not necessarily when it is paid.
- Origination Fees and Annual Fees: These fees are usually treated as prepaid expenses when they are initially paid, and they are then amortized over the life of the LOC as an expense. For example, if a company pays a $1,000 origination fee for a LOC that it expects to maintain for five years, it would record a $200 expense each year ($1,000 / 5 years).
To record these expenses in the company’s books, the following entries would be made:
- For the origination or annual fees: Debit (increase) the “Prepaid Expenses” account and credit (decrease) the “Cash” account. Then, over the life of the LOC, debit (increase) the “Interest Expense” account and credit (decrease) the “Prepaid Expenses” account.
- For the interest expense: Debit (increase) the “Interest Expense” account and credit (increase) the “Liabilities” account to reflect the increase in the amount owed.
Please note that the exact accounting treatment can vary depending on the specific circumstances and accounting policies, so it’s always a good idea to consult with a professional accountant or financial advisor.
Example of How a Line of Credit Fee Accounted For
Let’s say a business obtains a line of credit for $100,000 with an annual fee of $1,000 and an interest rate of 5%. Here’s how the company would account for the fees associated with the line of credit:
- Annual Fee: When the business pays the $1,000 annual fee at the beginning of the year, it would make the following entry in its accounting records:
- Debit (increase) “Prepaid Expenses” account by $1,000
- Credit (decrease) “Cash” account by $1,000
- Debit (increase) “Bank Charges Expense” account by $83.33 ($1,000 / 12 months)
- Credit (decrease) “Prepaid Expenses” account by $83.33
- Interest Expense: Assume that the company borrows the full $100,000 from the line of credit at the beginning of the year and does not make any payments during the year. With an interest rate of 5%, the company would accrue interest of $5,000 over the course of the year ($100,000 * 5%).If the company records this accrued interest expense monthly, it would make the following entry each month:
- Debit (increase) “Interest Expense” account by $416.67 ($5,000 / 12 months)
- Credit (increase) “Interest Payable” (a liability account) by $416.67
At the end of the year, the company would have recorded $1,000 in bank charges expense (the amortized annual fee) and $5,000 in interest expense, and it would show a $5,000 liability for the accrued interest payable.
As always, the exact accounting treatment can vary, so it’s always a good idea to consult with a professional accountant or financial advisor.
