Long Term Loans and Interest Print

Loans are presented on the balance sheet as a liability (amount owed by the company to third parties). They are split between current liabilities and long term liabilities.  Current liabilities are capital repayments due in the next accounting period (usually twelve months) and long term liabilities are amounts due in subsequent accounting periods.  

Interest paid on loans must be deducted from income to show net profit.

The entries to bring loans into the accounts are:

1. When the initial cash or asset is received

  • Dr Cash (or other balance sheet asset) with the amount received from the loan provider
  • Cr Loan account (balance sheet liability)

2. When repayments are made

  • Dr Loan account (balance sheet liability)
  • Cr Cash (balance sheet asset)

3. At the year end to show correct amounts in the accounts

  • Dr Interest (profit and loss account expense)
  • Cr Loan account (balance sheet liability)
  • Cr Long term liability (portion of loan due for repayment after 12 months)
  • Dr Loan account (balance sheet liability)

Calculating the amounts

Say you take a loan of £5,000 and repay it in 60 payments of £167. Your total repayments are therefore £10,020. £5,000 is called the capital amount and £5,020 is finance charges.

Each time you pay £167, it includes £83 (£5,000/50)capital and £84 (5020/60) interest. The interest portion must be deducted from the total loans received less all repayments to show how much you will have to pay to settle the loan on the balance sheet date.

Usually you can contact your loan provider and ask them how much you would have to repay on the balance sheet date to settle the whole loan and how much interest was charged in the accounting period. These are the figures presented in the balance sheet and profit and loss account.

Instead of contacting the loan provider, accountants prepare an amortisation schedule. To see an example, refer to the Preparation of Accounts section above and download the Extended Trial Balance spreadsheet and view the loans tab. The schedule is prepared from information in the loan agreement.

Interest is charged daily or monthly on the capital balance as a percentage of the balance outstanding. If the rate is 5% on a loan of £5,000, the interest for one month will be £5000 x .05/12 = £20.83. As the repayments reduce the capital balance, the amount of interest charged is reduced (eg £4000 x .05/12 = £16.67).

The loan agreement will show an interest rate which can be used to calculate the internal rate of return. The internal rate of return is the actual interest charged throughout the life of the loan. Interestingly the interest rate on the agreement is never exactly the same as the rate calculated in the amortisation schedule. It usually shows that the rate actually charged is more than the official rate stated in the agreement. 

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