How to Record a Loan Payment That Includes Interest and Principal
When you make a loan payment that includes both interest and principal, you will need to separate these two components in your accounting records. The principal payment will reduce your outstanding loan liability, and the interest portion is an expense.
Let’s go through the process:
- Identify Principal and Interest Portions: Your loan provider should provide a loan amortization schedule or statement that breaks down each payment into its principal and interest components.
- Record the Total Payment: First, record the total payment as a decrease in your bank account (or whichever account the payment was made from).
- Record the Principal Portion: The principal portion of the payment reduces your outstanding loan liability. So, debit (decrease) the loan liability account by the amount of the principal payment.
- Record the Interest Portion: The interest portion of the payment is an expense for your business. So, debit (increase) the interest expense account by the amount of the interest payment.
Example of How to Record a Loan Payment That Includes Interest and Principal
Let’s imagine a business that has taken out a loan and is now making a monthly payment of $500, of which $400 is the principal and $100 is the interest.
Here’s how these transactions would be recorded:
- Identify Principal and Interest Portions : According to the loan amortization schedule provided by the bank, the payment is split into $400 for the principal and $100 for interest.
- Record the Total Payment: The total loan payment will decrease the company’s bank account. The journal entry would be:DateAccount TitleDebitCreditJul 1Bank Account$500
- Record the Principal Portion: The principal portion will reduce the outstanding loan liability. The journal entry would be:DateAccount TitleDebitCreditJul 1Loan Payable$400
- Record the Interest Portion: The interest portion is considered an expense for the company. The journal entry would be:DateAccount TitleDebitCreditJul 1Interest Expense$100
In summary, the company’s bank account decreased by $500, the liability from the loan payable account decreased by $400, and the interest expense of $100 was recorded. Regularly making and recording such payments will ensure the company accurately tracks the reduction of its loan liability and its interest expenses.