To record a loan in accounting, you debit Cash and credit Notes Payable on the day the funds arrive, then split every monthly payment into three lines: a debit to Notes Payable for the principal portion, a debit to Interest Expense for the interest portion, and a credit to Cash for the total payment. At fiscal year end, you accrue any interest that has built up since the last payment. Everything else that comes up over the life of a loan — origination fees, line of credit draws, early payoff, forgiveness — is a variation on those two core entries.
What You Need Before Making the First Entry
Pull out the signed promissory note and the amortization schedule before touching the ledger. The note gives you the principal, the annual interest rate, the maturity date, and the payment amount. The amortization schedule breaks every future payment into its principal and interest components, month by month, and it becomes the reference you use for every entry over the life of the loan. Most lenders provide one at closing; if yours didn’t, you can build it from the numbers on the note.
Check that the rate and payment dates on the schedule match the lender’s records before you post anything. A mismatch now becomes a reconciliation problem later, and small discrepancies compound over months.
Set Up Four Ledger Accounts
You need four accounts in place before recording loan activity:
- Cash (or Bank), an asset account that holds the borrowed funds and pays out installments.
- Notes Payable, a liability account for the amount you owe. If any part of the balance is due beyond twelve months, split it into a current Notes Payable account (the next twelve months of principal) and a long-term Notes Payable account (everything after that). The split tells anyone reading your balance sheet how much cash pressure you face in the short term.
- Interest Expense, an income statement account that captures the cost of borrowing as each payment comes due.
- Interest Payable, a liability account used at year end for interest that has accrued but hasn’t been paid.
If the loan requires you to hold cash in a reserve account as a condition of borrowing, that money is restricted cash and generally sits as a non-current asset rather than in your operating cash account. Classifying it as regular cash overstates your working capital.
Record the Loan Disbursement
When the lender wires funds into your bank account, post the first entry. For a $50,000 loan:
- Debit Cash — $50,000
- Credit Notes Payable — $50,000
The debit increases your assets, the credit increases your liabilities, and the accounting equation stays balanced. Date the entry on the day the funds actually land in the account, not the day you signed the paperwork or the day the loan was approved. Attach the deposit confirmation or wire receipt as supporting documentation. If a discrepancy exists between the loan amount on the note and the amount deposited, the lender likely withheld fees at closing, which you handle separately below.
When the Lender Pays a Vendor Instead of You
Equipment loans, vehicle financing, and some real estate deals never route cash through your account. The lender pays the seller directly. Skip Cash and debit the asset instead. For a $30,000 piece of equipment:
- Debit Equipment — $30,000
- Credit Notes Payable — $30,000
From here, monthly payment entries work exactly the same as for any other term loan. You’ll also depreciate the equipment over its useful life on a separate schedule, so the asset’s book value and the remaining loan balance will diverge as time passes.
Handle Origination Fees the Right Way
Origination fees, processing fees, and other closing costs are not expensed immediately under GAAP. They’re deferred and amortized over the life of the loan as an adjustment to interest expense, because they’re part of the true cost of borrowing.1OCC – Treasury. Bank Accounting Advisory Series 2025
For a $1,500 origination fee on a five-year loan, post this at closing:
- Debit Deferred Loan Costs — $1,500
- Credit Cash — $1,500
Then amortize $25 each month using straight-line over 60 months:
- Debit Interest Expense — $25
- Credit Deferred Loan Costs — $25
On formal financial statements, deferred loan costs are presented as a direct reduction of the related debt’s carrying amount rather than as a standalone asset. If you pay the loan off early, expense any remaining unamortized fees in that period.
Record Each Monthly Payment
Every installment touches three accounts because it contains two economic components: principal reduction and interest. The amortization schedule tells you the split. For a $1,000 payment where month one breaks down as $800 principal and $200 interest:
- Debit Notes Payable — $800
- Debit Interest Expense — $200
- Credit Cash — $1,000
After posting, your Notes Payable balance should match the “remaining balance” column on your schedule for that month. If it doesn’t, find the error now. The most common bookkeeping mistake with loans is running the full payment against Notes Payable and ignoring the interest split. That understates your liability and understates your interest expense at the same time.
The principal-and-interest ratio shifts as the loan matures. Early payments lean heavily toward interest; later payments push more toward principal. Follow the schedule month by month rather than applying a flat ratio.
The interest portion of business loan payments is generally deductible under § 163 of the Internal Revenue Code, which allows a deduction for interest paid on indebtedness.2Office of the Law Revision Counsel. 26 US Code 163 – Interest Principal repayment is not deductible.
Accrue Interest at Fiscal Year End
Fiscal year ends almost never line up with payment dates, which means you owe interest that hasn’t been paid on the last day of the year. Accrual accounting requires you to recognize that expense in the period it was incurred. Skipping this adjustment is one of the more common errors in small business books.
Say your year ends December 31 and the next payment is due January 15. Calculate the accrued interest using the daily rate (annual rate divided by 365) multiplied by the days elapsed since the last payment. If that works out to $150:
- Debit Interest Expense — $150
- Credit Interest Payable — $150
When the January 15 payment posts, the interest portion is split: $150 debits Interest Payable to clear the accrual, and only the new January interest debits Interest Expense. Without the year-end entry, December’s financials understate both the expense and the liability.
Draws and Repayments on a Line of Credit
A revolving line of credit uses the same debit-and-credit logic as a term loan, but you’ll post entries far more often and the balance moves constantly. Drawing $10,000:
- Debit Cash — $10,000
- Credit Line of Credit Payable — $10,000
Repaying $5,000:
- Debit Line of Credit Payable — $5,000
- Credit Cash — $5,000
Interest is typically charged only on the outstanding balance and billed monthly. Record the interest charge with a debit to Interest Expense and a credit to Cash. Reconcile the Line of Credit Payable account against the lender’s statement every month without exception, because errors accumulate quickly on an account with frequent activity.
Early Payoff and Refinancing
Paying off a loan before maturity zeroes out the remaining Notes Payable balance. If $18,000 of principal remains and $75 of accrued interest is owed on the payoff date:
- Debit Notes Payable — $18,000
- Debit Interest Expense — $75
- Credit Cash — $18,075
Prepayment penalties get added as another debit to Interest Expense, or to a separate Prepayment Penalty account if you want the visibility. Any unamortized origination fees on the books get expensed in full at payoff, since there’s no remaining loan life to spread them over.
A refinance is two entries in sequence: one to extinguish the old debt on the standard payoff format, and one to record the new loan on the standard disbursement format. If the new lender pays the old lender directly, the two entries collapse into a debit to old Notes Payable and a credit to new Notes Payable, with any difference running through Cash.
When a Lender Forgives Debt
Forgiven debt doesn’t just disappear from the books. The canceled amount creates a gain on your income statement. For $12,000 of forgiven principal:
- Debit Notes Payable — $12,000
- Credit Gain on Debt Extinguishment — $12,000
On the tax side, canceled debt of $600 or more triggers a Form 1099-C from the lender, and the IRS generally treats the forgiven amount as taxable income.3Internal Revenue Service. Form 1099-C, Cancellation of Debt Exclusions exist for debt discharged in bankruptcy and for debt discharged while the business is insolvent (liabilities exceed the fair market value of assets), though the insolvency exclusion is capped at the amount of insolvency.4Office of the Law Revision Counsel. 26 USC 108 – Income From Discharge of Indebtedness Excluded amounts generally require you to reduce other tax attributes and report the result on Form 982. This is one area where professional tax help pays for itself.
Keep the Ledger Reconciled
The mechanics above work if you stay disciplined. Reconcile Notes Payable against the lender’s statement every month. Compare cumulative interest expense in your ledger to cumulative interest on the amortization schedule. When those numbers drift apart, something was posted wrong, and the fix gets harder the longer it sits. A loan that’s recorded cleanly from day one is a small monthly task; a loan that’s been posted haphazardly for a year is a project.