Journal Entry for Loan Payment (Principal & Interest)
Loans are a common means of seeking additional capital by the companies. They can be obtained from banks, NBFCs, private lenders, etc. A loan received becomes due to be paid as per the repayment schedule, it may be paid in instalments or all at once. Below is a compound journal entry for loan payment made including both principal and interest component;
| Loan A/C | Debit | Debit the decrease in liability |
| Interest on Loan A/C | Debit | Debit the increase in expense |
| To Bank A/C | Credit | Credit the decrease in Asset |
*Assuming that the money was due to be paid to ABC Bank Ltd.
Traditional Rules Applied
Loan Account (Personal) – Debit the Receiver
Interest Account (Nominal) – Debit all Expenses & Losses
Bank Account (Personal) – Credit the Giver
The repayment of a secured or an unsecured loan depends on the payment schedule agreed upon between both the parties. A short-term loan is categorized as a current liability whereas the unpaid portion of a long-term loan is shown in the balance sheet as a liability and classified as a long-term liability.
Example
The first of two equal instalments are paid from the company’s bank for 1,00,000 against an unsecured loan of 2,00,000 at 10% p.a. Show journal entry for loan payment in Year 1 & Year 2.
In Year 1
| Loan A/C | 90,000 |
| Interest on Loan A/C | 10,000 |
| To Bank A/C | 1,00,000 |
(The remaining amount of 1,00,000 due to be paid will appear in the balance sheet as a liability)
Related Topic – Journal Entry for Loan Taken from Bank
In Year 2
| Loan A/C | 90,000 |
| Interest on Loan A/C | 10,000 |
| To Bank A/C | 1,00,000 |
(As this would be the last instalment to pay the loan, therefore, this loan will not be shown in the balance sheet after this payment)
Impact on Accounting Equation
After the loan is paid off the net effect of these transactions on the accounting equation will be as follows;
The assets of the company decreased by 2,00,000, liabilities reduced by a 1,80,000 and simultaneously owner’s capital went down by the interest amount i.e. 20,000.
| Assets | = | Capital | + | Liabilities |
| -2,00,000 | = | -20,000 | + | -1,80,000 |
(The impact has been assessed at the end of all transactions)
Short Quiz for Self-Evaluation
>Read Types of Liabilities