How to Record the Payment of a Debt in Accounting

Paying off debts is always a good idea.

Companies borrow money from financial institutions in the form of loans and operating lines of credit, from suppliers in the form of notes payable, and from investors in the form of bonds. In return the lenders and investors require regular interest payments and the return of the principal or face value of the debt by a certain maturity date, which could be a few months for short-term debt and more than a year for long-term debt. Interest and principal payments must be recorded in the company's books when they are accrued and paid.

Instructions

1. Record regular interest payments. This can be done in two steps. On the day the interest becomes due, debit (increase) the interest expense account, which goes on the income statement and impacts profit, and credit (increase) the interest payable account, which is a balance sheet liability account. For example, if you have a $1,000 outstanding short-term note at 6 percent annual interest, then your monthly interest payment is $5: ($1,000 x 0.06) / 12. So debit interest expense $5 and credit interest payable $5.

2. Debit (decrease) the interest payable account and credit (decrease) the cash account, which is a balance sheet asset account, when you make the interest payment. In the example, the amounts would still be $5. Note that the terms of the debt may not require you to make monthly payments, but make one lump-sum payment on maturity that includes the principal and the total accrued interest.

3. Make the entries for principal payments. When you pay off short-term notes at maturity or earlier, debit (decrease) the notes payable account, which is a balance sheet liability account, and credit cash. For loans and long-term bonds, debit the corresponding loans payable or bonds payable accounts. To conclude the example, debit notes payable and credit cash by $1,000.

Tips & Warnings

• Note that debt repayment or principal payments are not expense items. So they do not impact a company's profit and loss statement.

References

• Cliffs Notes: Understanding Notes Payable
• WiseBread; Debt Repayment Is Not an Expense; Philip Brewer; August 2007