Often a loan payment consists of both an interest payment and a payment to reduce the loan's principal balance. The interest portion is an expense whereas the principal portion is a reduction of a liability such as Loans Payable or Notes Payable.
If a company uses the accrual method of accounting, it is logical to record the interest expense and the interest liability at the end of each accounting period (instead of recording the interest expense when the payment is made). This is done with an adjusting entry in order to match the interest expense to the appropriate accounting period. It also results in the reporting of a liability for the amount of interest that the company owes as of the date of the balance sheet.
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