How to Record Loans and Interest Properly in Your Books

October 29, 2025

Introduction

When your business takes on a loan or when you need to track interest getting the bookkeeping right is key. Proper recording keeps your financial statements accurate, supports tax compliance, and helps you make better decisions. In this post, we’ll clearly walk you through how to record:

Receiving the loan funds
Separating interest vs principal
Recording repayments
Dealing with accrued interest
Best practices for bookkeeping

Whether you’re using software like QuickBooks or doing manual journals, you’ll be set up for success.

Why it matters (and common pitfalls)

First, let’s clarify why correct loan and interest bookkeeping is important:

The loan principal is a liability: it appears on the balance sheet, not as an expense.
The interest portion is an expense: it appears on the income statement and affects profit.
Mixing them up can over-state expenses, under-state liabilities—and mislead you or your accountant.
Tax and audit considerations: Interest may be tax-deductible; principal repayments are not.

Common mistakes:

Recording the entire loan repayment as an expense (wrong).
Forgetting to separate out interest vs principal.
Not creating a liability account for the loan.
Omitting accrued interest at period end.

Step-by-Step Guide to Recording Loans & Interest

Here is how to do it properly in your bookkeeping.

1. When you receive the loan

When your business receives a loan, you’re increasing cash (or a bank account) and creating a liability (Loan Payable).
Journal entry example:

Debit: Cash or Bank (asset)
Credit: Loan Payable (liability)
For example, borrowing $50,000 → Debit Cash $50,000; Credit Loan Payable $50,000.

This shows you now owe $50,000.

2. Setting up separate accounts

It’s best practice to set up distinct accounts:

A “Loan Payable – Long-Term” (or current portion if applicable) liability account.
An “Interest Expense” account for the interest payments.
This will help you track how much principal remains and how much interest you’ve incurred.

3. Making repayments (principal + interest)

Most business loans include both principal and interest in each payment. Here’s how to record when you make a payment:

Determine how much of the payment is principal and how much is interest.
Record the interest portion as Interest Expense.
Record the principal portion as a reduction of the Loan Payable liability.
Credit Cash for the total payment.

Example: Payment of $2,000 where $500 is interest and $1,500 is principal.

Debit: Interest Expense $500
Debit: Loan Payable $1,500
Credit: Cash $2,000

This correctly reduces your liability by $1,500 and records the cost of borrowing as $500 expense.

4. Accruing interest (if needed)

If your accounting period ends and you owe interest that hasn’t yet been paid (or invoiced), you should accrue it:

Debit: Interest Expense
Credit: Accrued Interest Payable (liability)
This matches the expense in the correct period and shows the obligation.

5. Classifying current vs long-term portions

If your loan has a repayment schedule stretching beyond 12 months, part of the liability is “current” (due within the next year) and part is “long-term” (due after). Your balance sheet should reflect this separation.

6. Paying off the loan completely

When you make the final payment and extinguish the loan:

Debit: Loan Payable (remaining balance)
Credit: Cash (or Bank)
If any final interest is included, also do the interest portion accordingly.

Practical Tips & Best Practices for Bookkeepers

Use amortization schedules from the lender (or create one) to know how much interest vs principal applies each payment.
Review your liability account’s balance monthly to ensure it matches lender statements.
Mark interest payments clearly in your bookkeeping system—this helps for tax deduction purposes.
If you pay interest only (loan structure), you will have only interest expense, and the full principal remains until maturity.
Keep supporting documentation: loan agreements, payment schedules, and lender statements.
In software (QuickBooks, Xero, etc), map the accounts correctly: Loan Payable for liability; Interest Expense for expense.
If your business uses cash basis accounting, you still need to record liability and interest when incurred—but consult your accountant for period-specific rules.
Consider creating a note under the contingent liabilities in your financial statements if there are guarantees or unissued parts of the loan.

FAQ: Quick Answers

Q: Is the full loan payment an expense?
A: No. Only the interest portion is recorded as an expense. The principal portion reduces the liability.

Q: Can I deduct the principal repayment on tax?
A: Generally, no. Principal is not a deductible expense, it’s a repayment of debt. Interest typically is deductible (consult tax rules).

Q: What if the loan is from the owner (shareholder loan)?
A: Same principle: Credit a Loan Payable (owed to owner), and treat payments as principal/interest accordingly. Follow your agreement details.

Q: How do I classify interest paid for tax purposes?
A: If the loan is for day-to-day operations, interest is an operating expense. If the loan is tied to acquiring a fixed asset, interest might be capitalized (check tax rules)

Summary

Recording loans and interest properly is foundational to clean bookkeeping:

Set up the correct loan liability account when funds are received.
Create separate accounts for interest expense.
Split each payment into principal (reduces liability) and interest (expense).
Accrue unpaid interest at period-end.
Track current vs long-term portions of debt.
Keep documentation, use amortisation schedules, and align with tax rules.

By following these steps, you’ll ensure your books present an accurate picture of your debt, costs, and obligations. This clarity is invaluable not only for tax time, but for dashboards, dashboards, lending, and business decision-making.

How Accredited Bookkeeping Can Support Your Business

At Accredited Bookkeeping, we understand the challenges small businesses face when it comes to managing finances. We’re here to help you streamline your bookkeeping processes, avoid unnecessary financial errors, and gain greater clarity about your financial health. Our services are designed to fit the specific needs of your business, giving you peace of mind while you focus on growth.

📧 marianne@accreditedbookkeeping.com

Marianne Kirwan

📞 352-626-0116

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