Definition of Loan Principal Payment
When a company borrows money from its bank, the amount received is recorded with a debit to Cash and a credit to a liability account, such as Notes Payable or Loans Payable, which is reported on the company's balance sheet. The cash received from the bank loan is referred to as the principal amount.
The principal amount received from the bank is not part of a company's revenues and therefore will not be reported on the company's income statement. Similarly, any repayment of the principal amount will not be an expense and therefore will not be reported on the income statement. The principal payment is recorded as a reduction of the liability Notes Payable or Loans Payable. (Both the receipt of the loan principal amount and the repayment of the loan principal will be reported on the statement of cash flows.) The interest on the loan will be reported as expense on the income statement in the periods when the interest is incurred.
Example of a Loan Principal Payment
Let's assume that a company borrows $10,000 from its bank. The company's cash increases by $10,000 and its liability Loans Payable increases by $10,000. Let's also assume that the company makes a payment of $1,000 consisting of $60 for interest and $940 for principal, the entry will be:
- Debit of $60 to Interest Expense (an income statement account)
- Debit of $940 to Loans Payable (a balance sheet account)
- Credit of $1,000 to Cash (a balance sheet account)
Notice that only the interest expense of $60 will be included on the income statement.