How do I account for interest?
Say that I have 4 accounts in my system, Assets, Loan, Principle and Loan, Interest (Liabilities) and Expenses. I borrow $1000 + $100 interest.
I know that I Debit Assets $1000 and Credit Loan, Principle $1000 when I get the loan.
I think I should also Debit Loan, Interest $100 since it is a liability I will have to pay.
My problem is that I also think I should Debit Expenses and Credit Assets when I make an interest payment. Then, if I’m going to reduce the liability shown in Loans, Interest, I need to Credit that account, but what-n-heck do I Debit?
Or am I totally out of the ballpark?
Thanks mucho, guys.
He He Ha Ha Ho Ho! They’re coming to take me away, He He!
Replies
I don't know about the double entry systems.
But loan interest is an expense. Not a liability.
However when you make the load payment, in may cases it is amortized and part of the payment is princile which will reduce the loan liability, part interest expense.
Bill,
Thanks for taking an interest in my problem.
I got the part about it being an expense. . .
Hmnn, Maybe I should post the entire years interest to expenses at the start , then treat the liability like an accounts payable. That would at least balance out.
IOW, Debit expenses, Credit Loans, Interest, for the $100, then, as I make payments, Debit Loans, Interest.
Yeah, that makes sense.
Thanks again, Bill, sometimes just hearing someone elses thoughts is all it takes.
SamT
Sam,
Your loan is a liability which belongs to the Balance Sheet that states your assets and liabilities and you capitol, while loan interest is an expense which belongs to your Income Statement.
Loan interest only belongs to accounts payable when it's dued but not paid.
Sam- IIRC from back in school, you would debit the expense and credit cash when the check is written. Anyway, that would be my way of handling. (Debiting the expense might work, but how does that account for the cash account?)
Don K.
EJG Homes Renovations - New Construction - Rentals
Don,
Here's what I came up with;
Debit cash for the loan recievedCredit current loans principle for the principle due this yearCredit Long term debts for the balance of the loanDebit expenses for the interest due this yearCredit current interest for the same.
When making a payment
Credit cash for the total paymentDebit current loans for the principle part of the payment, and,Debit current interest for the interest part.
Tom, If I understand you correctly, Interest doesn't get entered in the books until it's due? So there is no way of accounting for the total interest owed, but not yet due?
That almost seems to make more sense than what I've written above, because putting the whole years interest in would certainly skew the early P&Ls.
Ya-no? I almost got that head sized hole drilled thru that block wall.SamT
"That almost seems to make more sense than what I've written above, because putting the whole years interest in would certainly skew the early P&Ls."The interest expense is a current expense just like the utility bill.You don't owe any future interest until it is due as you can alwasy pay off the loan early.Now if you want to do some cash flow predictions then you need to account for future interest payments, but again just like you need to account for future utility payments.
Got it!
Thanks, Bill,
SamT
Are you using accrual or cash accounting to maintain your general ledger?
The answer changes, depending on which method you use.
-Jazzdogg-
"Don't ask yourself what the world needs. Ask yourself what makes you come alive, and go do that, because what the world needs is people who have come alive." Gil Bailie
Are you using accrual or cash accounting to maintain your general ledger?
Uuhhh. . . I'm not sure of how to tell the difference.
I debit expenses when things are recieved. If not paid ATT, credit them to liabilities until paid.
Credit income when a project is sold, then credit A/R when money is received.
Bills get credited to liabilities when received. Debited there when paid.
I've got this little truth table I use;
Start
Middle
End
Credit Income
Debits = Credits
Debit Cash
Debit Expense
Credits = Debits
Credit Cash
Any part of a loan due this year I credit to current liabilites and debit when paid. The balance goes in long term to carry over to next year. I debit interest into expenses monthly.SamT
When recording general ledger entries on a cash basis, revenue is recorded when payment is received, expenses when checks are written. On an accrual basis, revenue is credited when earned (with an offseting debit to A/R); when cash is received, cash is debited and accounts receivable is credited.
Taxing authorities tend to become upset when entries aren't recorded on a basis that's consistent with the kind of entity (sole proprietorship, partnership, corporation, etc.); problems also arise when some kinds of items are recorded on a cash basis and others are recorded on an accrual basis. Some business entities record G/L entries on an accrual basis, but convert the entries to a cash basis for tax purposes at year-end.
On an accrual basis, when a loan is received, one would debit cash and credit liabilities - splitting the liability between a short-term liability account for the portion that pertains to the current fiscal year, and a long-term liability account for the portion that will be expensed in future fiscal years.
Hope that helps,
-Jazzdogg-
"Don't ask yourself what the world needs. Ask yourself what makes you come alive, and go do that, because what the world needs is people who have come alive." Gil Bailie
So a Cash basis accounting system doesn't have Liabilities, A/R, or A/P accounts?
Edit: I figured on entering sales when it was sold, not when it was delivered. Is that a major goof? Will it land me in jail?
I really didn't think it mattered that much, since everything has to be zero'd out at years end. (Sole Prop)
SamT
Edited 3/23/2006 6:37 pm by SamT
Hi Sam,
There are assets, liabilities, and equity accounts on the general ledger - whether you are recording entries on a cash or an accrual basis.
As an example, since it entirely possible to obtain loans, and other liabilities, while maintaining one's books on a cash basis, you'll need to set up appropriate liability accounts in which you record the necessary entries.
Re: accounts receivable, you can definitely record sales and A/R when you complete a sale (booking a debit to cash and a credit to A/R as payments are received), but for tax purposes you may have to restate your revenue on the basis of payments received - check with your CPA to see what works in your personal situation: the trick is to record your accounting transactions in a way that works for you, your CPA, and the IRS.
Good luck,
-Jazzdogg-
"Don't ask yourself what the world needs. Ask yourself what makes you come alive, and go do that, because what the world needs is people who have come alive." Gil Bailie
JD,
Whew, ya had me worried there for a while.
So it's mostly an end-of -the-year thing? Yeah, I knew that by Dec I would have to have a CPA involved. I'll be filing on a Cash basis and I've set up my COA to make that as easy as I can foresee.
In my last actual business, as opposed to making a job for myself, I gave all the papers to my CPA, (a long time friend) every week. This time I'm setting up my COA to give me the info that I think I need, hopefully in a manner that is easily expandable as I learn more.
There are a few theory questions that show up the holes in my knowledge. OK, OK, they're canyons, not holes.
Fer incense, Interest; I know I owe the money, so it sounds like a liability, but I couldn't make it work, ie balance to zero, that way. Now, thanks to you and the rest of the Breaktime University staff, I see that, technically, I don't owe the interest until it comes due.SamT
SamI don't know if you are doing this with any software or not.But I have never understood double entry, but I could tell you how to do this in Quicken.It is all in the reports.You can log a bill into and AR when you get it (or in the future is if you already know what it is such as a monthly insurance payment).Then when you make the payment you enter it as a transfer from the checking account to the AR account.However, CC charges would be put in a separate CC account. They for tax purpouse you can deduct them when you made the charge, not when the account is paid. (Great for last minute end of the year tool purchases).Like wise for an AR account. And when you get paid you show the payment as atransfer from AR to checking. Then when you run your cash basis report you would include the checking account and CC account, but exclude the AR and AP. Then you select the option to exclude internal transfers (with in the selected accounts). Thus your report shows the charges to the CC account and when money is receive (from the AR account) and when payments are made to the AP account.
Hi Sam,
I am preparing to teach a college course on business skills for woodworkers (primarily furniture and cabinet makers).
I am interested in hearing about the things that have been the greatest surprises, roadblocks, and challenges for people when they decided to hang out their shingle.
What would you recommend I definitely include in my talking points?
Also, care to share your chart of accounts?
Thanks,-Jazzdogg-
"Don't ask yourself what the world needs. Ask yourself what makes you come alive, and go do that, because what the world needs is people who have come alive." Gil Bailie
JD,
Gimmee a day or 2, I'll get bakatchaSamT
Sam,
THANKS!
-Jazzdogg-
"Don't ask yourself what the world needs. Ask yourself what makes you come alive, and go do that, because what the world needs is people who have come alive." Gil Bailie