Long Term Borrowings
In this lesson, we will learn how to calculate loan repayments and how to record loans in the journal and ledger accounts. We will also learn how to calculate interest expense, interest paid and interest expense payable, and how to record them in the journal.
Related Lessons:
Accounting for Loans
Loans are funds obtained from external parties to fund the daily operation of the business. The loan is repaid over a period of time beyond one accounting year. Therefore, it is recorded as a Non-Current Liability of a business.
To record the borrowing:
Dr Cash at bank
Cr Loan
To record the repayment of loan:
Dr Loan
Cr Cash at bank
A loan is repaid over a fixed period in fixed instalments. The portion that must be repaid within the next accounting period is no longer treated as a long-term liability. Therefore, it is reclassified from non-current liability to current liability and recorded as the “current portion of long-term borrowings.” Since this is only a reclassification, no double entry is required.
Watch: Full Concept Breakdown
Calculating Interest Expense
Interest is payable on outstanding loan amount on a fixed date and at a fixed annual interest rate.
To calculate interest expense
Interest expense = Outstanding loan amount × Annual interest rate
Example:
Outstanding loan amount is $50,000
Interest rate is 2% per annum
Interest expense = 50,000 x 2% = $1,000
If the loan is outstanding for less than a full year, the interest expense is adjusted based on the number of months it is outstanding.
Assuming the above loan is outstanding for 3 months, the interest expense will be adjusted as follows:
Interest expense = 50,000 x 2% x 3/12 = $250
Calculate Interest Paid
To calculate interest expense paid
Outstanding loan amount × Annual interest rate
This gives us the annual amount of interest expense paid.
If interest expense is payable on a quarterly or half yearly basis, interest expense paid is adjusted based on the number of months it is due for payment.
Interest Expense with Different Loan Amounts
When part of the loan is repaid during the accounting period, interest expense is calculated separately based on the outstanding loan amount before repayment and after repayment.
Example:
Accounting period of business is from 1 January to 31 December 20X1.
Loan on 1 January 20X1 is $50,000
Loan paid on 1 July 20X1 is $10,000
Interest is at 2% per annum
Interest expense from 1 January to 30 June 20X1
= 50,000 x 2% x 6/12 = $500
Interest expense from 1 July to 31 December 20X1
= (50,000 – 10,000) x 2% x 6/12 = $400
Total interest expense for the year = 500 + 400 = $900
Recording Interest Expense in Journal
Interest expenses are recorded in the journal as follows:
Interest payable brought forward from previous accounting period:
Dr Interest payable
Cr Interest expense
Interest paid:
Dr Interest expense
Cr Cash at bank
Interest due but not paid:
Dr Interest expense
Cr Interest payable
Interest expense incurred for the year:
Dr Income summary
Cr Interest expense
Recording Loan & Interest Expense in the Financial Statements
Loan is recorded in the Statement of financial position as Long-term borrowings.
The portion of the loan that is repayable within one accounting year is recorded in the statement of financial position as Current portion of long-term borrowings.
In the Statement of Financial Postion
Non-current Liability
Long-term borrowings
Current Liability
Current portion of long-term borrowings
Interest expense is recorded in the Statement of financial performance as Interest expense.
In the Statement of Financial Performance
Less Expense
Interest expense
Interest expense owing is recorded in the statement of financial position as Interest payable.
In the Statement of Financial Postion
Current Liability
Interest payable