Loan and Interest Expense Accounting

Loan accounting involves recording the initial loan proceeds as a liability and tracking repayments over the loan term.

Interest expense must be recognized periodically based on the outstanding loan balance and applicable interest rate.

Proper accounting for loans ensures accurate presentation of liabilities, interest expenses, and cash flows in financial statements.

Errors in loan and interest recording can lead to misstated liabilities, incorrect expense recognition, and non-compliance with debt covenants.

Overview / Definition

A loan is a financial liability representing borrowed funds that must be repaid over time, often with interest.

Loans may be classified as short-term or long-term liabilities depending on the repayment schedule.

Interest expense is the cost of borrowing and is recorded periodically based on the loan agreement.

Accounting for loans and related interest follows the effective interest method or the straight-line method depending on the complexity of the arrangement.

Recognition and Measurement

Initial Loan Recognition:

✦ Record the cash received and recognize the loan as a liability.

✦ If the loan includes origination fees or transaction costs, adjust the loan balance accordingly under the effective interest method.

Example – Loan Received:

• Loan Amount: $100,000

• Interest Rate: 6% Annual

• Loan Term: 5 Years

Initial Journal Entry (Loan Received):

debit Cash – 100,000

credit Loan Payable – 100,000

Interest Expense Recognition (Monthly):

• Monthly Interest = $100,000 × 6% ÷ 12 = $500

Journal Entry:

debit Interest Expense – 500

credit Interest Payable – 500

Loan Repayment Entry (Principal + Interest):

• Monthly Payment: $2,000 (Assuming fixed installment)

• Principal Portion: $1,500

• Interest Portion: $500

debit Loan Payable – 1,500debit Interest Payable – 500

credit Cash – 2,000

Journal Entry Examples

1. Recording Loan Origination Costs ($2,000):

debit Cash – Deferred Loan Costs – 2,000

credit Loan Payable – 100,000

2. Amortization of Loan Origination Costs (Straight-Line Over 5 Years):

debit Interest Expense – 400

credit Deferred Loan Costs – 400

3. Final Loan Settlement:

debit Loan Payable – 100,000

credit Cash – 100,000

Disclosure Requirements

Companies must disclose:

✦ Total outstanding loan balances by maturity (short-term and long-term portions).

✦ Details of significant loan agreements, including interest rates, maturity dates, and covenants.

✦ Total interest expense recognized during the reporting period.

✦ Any restrictions or pledged assets related to borrowings.

Disclosures are typically included under the Liabilities and Notes Payable sections of the financial statements.

IFRS Comparison

Criteria	US GAAP	IFRS
Initial Measurement	At Fair Value	At Fair Value
Subsequent Measurement	Amortized Cost	Amortized Cost
Interest Recognition	Effective Interest or Straight-Line	Effective Interest Method
Loan Fees Treatment	Deferred and Amortized	Deducted from Loan Carrying Amount
Disclosure of Covenants	Required	Required

IFRS typically requires the effective interest method for amortization, ensuring a more accurate reflection of borrowing costs over time.

Common Errors

✦ Failure to Recognize Accrued Interest: Omitting unpaid interest at period-end, leading to understated liabilities and expenses.

✦ Incorrect Classification of Loan Liabilities: Misclassifying long-term loans as current or vice versa, affecting liquidity ratios.

✦ Ignoring Loan Origination Fees: Not amortizing fees over the loan term, resulting in inaccurate expense recognition.

✦ Using Incorrect Interest Calculation Methods: Applying the straight-line method where the effective interest method is required.

✦ Non-Disclosure of Debt Covenants: Failing to disclose important loan conditions, increasing audit and compliance risks.