Definition of Loan Payment
Generally a loan payment consists of:
- An interest payment, which is an expense
- A principal payment, which reduces the loan's principal balance
If the interest and principal portions of the loan payment are not listed, a loan amortization schedule will indicate the amounts.
If the loan payments are made on the last day of every month, the interest payment (or interest portion of the loan payment) will likely be the expense for the month. However, if the loan payment is made on a different day of the month, an accrual adjusting entry will be required to report the precise amount of interest for the month and the accrued interest liability at the end of the month.
The loan's principal balance is a liability such as Loans Payable or Notes Payable. The principal payments that are required in the next 12 months should be classified as a current liability. The remaining amount of principal owed should be classified as a long-term (or noncurrent) liability.
Example of Loan Payment
A company makes monthly payments of $500.00 on the last day of every month. Each month the interest portion decreases and the principal portion increases (as the result of a decreasing principal balance). A loan amortization schedule indicates that the interest portion of this month's payment is $112.49 and the principal portion is $387.51. Therefore, the loan payment will be recorded as follows:
- Debit Interest Expense for $112.49
- Debit Loan Payable for $387.51
- Credit Cash for $500.00