Businesses often require financing. They seek funds to expand, to compensate for slow sales or to purchase new equipment. When a business enters into a loan agreement, it receives cash in exchange for the promise to repay the amount borrowed plus interest. Before the company records the loan in the accounting records it needs to set up the loan in the company’s chart of accounts.
Loan Account Classification
A loan represents a liability to the company. Liabilities refer to obligations the company owes to other parties. The company needs to determine whether the loan falls into the classification of a current liability or a long-term debt. A current liability refers to obligations that must be paid within one year. A long-term debt refers to obligations that extend beyond one year. The accountant considers the length of time until the loan is due. If the loan is due within one year, the accountant classifies the loan as a current liability. If the loan extends beyond one year and payments start within a year, the accountant classifies the portion to be paid within the year as a current liability and the remaining amount as a long-term liability. If the loan extends beyond one year and no payments are due within a year, the accountant classifies the entire loan as long-term debt.
Chart of Account Format
A chart of accounts maintains a list of all financial accounts used by a business. The basic format of the chart of accounts includes an account number and an account description. More advanced charts of accounts might include additional information, such as account classification or an additional description. Charts of accounts follow a standard numbering pattern. Asset accounts begin with the digit 1. Liability accounts begin with the digit 2. Equity accounts begin with the digit 3. Revenue accounts begin with the digit 4. Expense accounts begin with the digit 5. The number of digits in an account number varies depending on the preference of the company.
Flexible Numbering System
Charts of accounts use flexible numbering systems. The best use of the chart of accounts includes planning the list to allow similar accounts to be grouped together. As the accountant assigns numbers to each account, she skips numbers in between rather than numbering each account consecutively. This allows the accountant to add new accounts in the future while grouping the new accounts with similar existing accounts.
Assigning Account Number
Within the liability accounts section, the accountant reviews the type of accounts needed to record the loan. This may include a long-term debt, a current liability or both. The accountant locates similar existing accounts in the liability section. The accountant assigns an unused account number near the similar accounts to each new account he creates.