Debt accounting

Debt is defined as an amount owed for funds borrowed. There are several issues that the borrower must be aware of when accounting for debt. The initial issue is how to classify the debt in the accounting records.

Here are the main areas to be concerned about:

  • If the debt is payable within one year, record the debt in a short-term debt account. This is a liability account. The typical line of credit is payable within one year, and so is classified as short-term debt.
  • If the debt is payable in more than one year, record the debt in a long-term debt account. This is a liability account. 
  • If the debt is in the form of a credit card statement, this is typically handled as an account payable, and so is simply recorded through the accounts payable module in the accounting software.

The next debt accounting issue is how to determine the amount of interest expense associated with debt. This is usually quite easy, since the lender includes the amount of the interest expense on its periodic billing statements to the company. In the case of a line of credit, the borrower is probably required to maintain its primary checking account with the lending bank, so the bank simply deducts the interest from the checking account once a month. This amount is usually identified as an interest charge on the bank statement, so the bookkeeper can easily identify it and record it as part of the monthly bank reconciliation adjustments. Alternatively, the lender may provide an amortization table to the borrower, which states the proportions of interest expense and loan repayment that will comprise each subsequent payment made to the lender.

The next issue is how to account for the various debt-related transactions. They are as follows:

  • Initial loan. When a loan is first taken out, debit the cash account and credit either the short-term debt account or long-term debt account, depending on the nature of the loan.
  • Interest payment. If there is no immediate loan repayment, with only interest being paid, then the entry is a debit to the interest expense account and a credit to the cash account.
  • Mixed payment. If a payment is being made that includes both interest expense and a loan repayment, debit the interest expense account, debit the applicable loan liability account, and credit the cash account.
  • Final payment. If there is a final balloon payment where most or all of the debt is repaid, debit the applicable loan liability account and credit the cash account.