# Why are loan costs amortized?

Author:
Harold Averkamp, CPA, MBA

## Definition of Loan Costs

Loan costs may include legal and accounting fees, registration fees, appraisal fees, processing fees, etc. that were necessary costs in order to obtain a loan.

If the loan costs are significant, they must be amortized to interest expense over the life of the loan because of the matching principle.

## Example of Amortizing Loan Costs

Assume that a company incurs loan costs of \$120,000 during February in order to obtain a \$4 million loan at an annual interest rate of 9%. The loan will begin on March 1 and the entire \$4 million of principal will be due five years later. In addition to the one-time loan costs of \$120,000 the company will also have the cost of the borrowed money which is \$360,000 (\$4 million X 9%) of interest each year for five years.

It would be misleading to report the entire \$120,000 of loan costs as an expense for the month of February. Hence, the matching principle requires that each month during the life of the loan the company should report \$2,000 (\$120,000 divided by 60 months) of loan costs as interest expense in addition to the interest expense of \$30,000 per month (\$4 million X 9% per year = \$360,000 per year divided by 12 months per year). The combination of the monthly amortization of \$2,000 and the monthly interest expense of \$30,000 results in total monthly interest expense of \$32,000 for each of the 60 months beginning on March 1.

When the note is issued and the loan costs are incurred, the company will debit a liability account such as Deferred Debt Issuance Costs for \$120,000. This account balance is presented along with the \$4,000,000 credit balance in Notes Payable. The result will be an initial net long-term liability of \$3,880,00 and a net cash increase of \$3,880,000. Each month the company will amortize the debt issue costs by crediting Deferred Debt Issue Costs for \$2,000 and debiting Interest Expense for \$2,000.

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#### About the Author

For the past 52 years, Harold Averkamp (CPA, MBA) has
worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com.