A loan payment isn't entirely an expense; it's split into two parts: the interest portion is an expense (the cost of borrowing), while the principal portion is a reduction of your loan liability (not an expense). For personal finance, it's often tracked as a transfer, but for business accounting, you separate interest (recorded as an expense on the income statement) from principal (reducing the loan on the balance sheet).
Loan payments are not a single expense category. They consist of two parts, each categorized differently: Interest Expense: The portion of the payment that covers the cost of borrowing the money (the interest) is an interest expense.
Classifying loan payment expenses
Loan payments typically consist of two parts: principal and interest. Interest payments: Considered an operating expense because they're the cost of borrowing money for your business activities. You'll record interest payments as an expense on your income statement.
Bank Loan Payments Category
Principal Repayment (Not an Expense): The principal portion of your payment is the return of the money you borrowed. This is not a deductible expense. Instead, it is a reduction of a liability on your company's balance sheet.
The repayment of the capital element of a loan is never deductible. However, interest paid on loans to or overdrafts of a business is a deductible expense, provided the loan was made wholly and exclusively for business purposes.
To be deductible, a debt must be a bona fide loan with an expectation of repayment and may include interest and a promissory note. The debt must be 100% worthless before it can be deducted.
All loan payments have two transactions: the negative transaction of money leaving your bank account and the positive transaction of money paid towards the debt, decreasing what you owe. The negative transaction should be categorized as the expense, so your budget will reflect your spending on that category.
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Usually, for borrowing companies and sole traders, a bank loan is a liability, not an asset. However, this can get a little confusing when a bank loan is taken out to purchase a specific asset and the asset is used as collateral for the loan.
Interest – only the interest portion of loan repayments are counted as an expense. The principal is not an operating expense. Principal repayments are recorded as a finance expense.
They're part of your financing. Loans aren't income because you're borrowing money, not earning it. And when you repay the loan principal, you're returning borrowed funds, not incurring an expense. That's why neither the loan amount nor principal payments appear on your P&L.
Likewise, payments of cash for interest on loans with a bank or on bonds issued are also included in operating activities because these items also relate to net income.
Non-performing loans (i.e. that have not been serviced for some time) are included as a memorandum item to the balance sheet of the creditor but no impairment loss is recorded. - Nominal value and market equivalent value should be disclosed. Debt securities are recorded at market value.
A business's financial obligations—like SBA 7(a) loan payments, salaries, mortgages, and deferred payments—are considered liabilities. Liabilities are deducted from a business's total equity.
A payment is a disbursement of money (usually in the form of a check or currency). Some payments are current period expenses (e.g. current month's rent payment) but many payments are not expenses of the current period.
Business loan repayments by themselves are not tax deductible because they aren't considered a business expense. They're repayments of money your business has borrowed.
When a company borrows money from its bank and agrees to repay the loan amount within a year, the company will record the loan by increasing its cash and increasing a current liability such as Notes Payable or Loans Payable.
A loan is not considered as income because the company is expected to pay that money back to the creditor overtime, meaning it is only reflected on the company's balance sheet. However, any interest that is accrued or paid on the loan during the period, goes in the income statement as an expense.
Example of Loan Payment
Let's assume that a company has a loan payment of $2,000 consisting of an interest payment of $500 and a principal payment of $1,500. The company's entry to record the loan payment will be: Debit of $500 to Interest Expense. Debit of $1,500 to Loans Payable.
In QuickBooks Online, you can set up a liability account to record the loan and its payments. This account tracks what you owe.
Create a journal entry.
Here's how to record a loan in QuickBooks Online:
If a company borrows money, this is a financing activity. There are some inflows from financing activities including borrowing money or selling common stock. Outflows from financing activities include paying the principal part of debt (a loan payment), buying back your own stock or paying a dividend to investors.
Solution: Loan repayments are a type of fixed expenditure. This is because the payment amount is usually set and must be paid regularly over a specific period.