How to record a loan payment: principal and interest, split right.

Knowing how to record a loan payment with principal and interest split correctly is one of those bookkeeping basics that's easy to skip and expensive to get wrong. Most people's first instinct is to categorize the whole monthly payment as an expense. It isn't. Part of it is just you paying back money you borrowed.

This guide uses a common example: buying equipment on a store financing plan, the kind offered at checkout by providers like Flexiti, and paying it off monthly. The same method works for a bank term loan, a vehicle loan or a line of credit.

1Why a loan payment isn't one expense

When you borrow money, you get cash (or an asset) and a liability: the amount you owe. Neither one is income or an expense. Borrowing doesn't make you richer, and repaying doesn't make you poorer. You're just moving money between the bank and the debt.

The only real cost is interest, the price of borrowing. That's the part that goes on your profit and loss statement. If you're new to how liabilities and expenses behave, our guides to double entry bookkeeping and debits and credits are good primers.

2A worked example: salon equipment on store financing

Say you own a GST-registered salon in Mill Woods. You buy a set of styling chairs and a shampoo station for $6,000 plus $300 GST, and finance the full $6,300 through the store's financing plan. In this example the plan charges 12% a year (1% a month) over 12 months, so the payment is $559.75 a month. Real plans vary a lot: some have promotional 0% periods, some charge fees, and some charge much higher rates. Use the numbers on your own agreement.

Entry 1: the purchase

No cash has moved yet, but you own $6,000 of equipment, you can claim the $300 GST as an input tax credit in the period of the purchase, and you owe the lender $6,300. The equipment isn't expensed all at once; it's claimed over time through capital cost allowance. See capital cost allowance explained.

The amortization schedule

Each month, interest is charged on the balance still owing. As the balance falls, the interest falls and more of each payment goes to principal.

Over the year you pay $6,716.97, but only $416.97 is an expense. The other $6,300 just pays off the liability.

Entry 2: the first monthly payment

Month two is the same shape with $501.72 to the liability and $58.03 to interest, and so on down the schedule.

3Where to get the principal and interest split

• The lender's statement. Most monthly statements show interest charged, fees and the new balance. This is the best source because it's what the lender actually charged.
• The amortization schedule you received when you signed. Good for fixed-rate term loans.
• A quick calculation. Interest for the month is roughly the opening balance times the monthly rate (annual rate divided by 12). The rest of the payment is principal. Use this as a check, not a replacement for the statement.

Store financing and revolving credit plans often behave more like a credit card than a term loan. Interest may be charged only after a promotional period, fees may appear on some statements, and the payment may change. Book whatever the statement shows each month.

4How to record a loan payment in QuickBooks Online

• Create the liability account. In the chart of accounts, add an account for the lender. Use a current liability type for debt due within a year, or a long-term liability type for longer loans.
• Record the purchase. Use a bill or a journal entry for the equipment and GST, with the financing liability account on the other side. If a bank loan deposited cash instead, record the deposit to the loan account.
• Record each payment. When the payment appears in the bank feed, open it and use split (or create an expense or cheque with two lines): principal to the loan liability account, interest to Interest expense. No GST tax code on either line.
• Reconcile the loan. At month end, reconcile the loan account against the lender's statement so the balance in QuickBooks matches what you actually owe.

Loan payments are a poor fit for bank rules, because the split changes every month. If you do use a rule, have it suggest the payee and account but leave the split for you to enter. More on that in our QuickBooks bank rules guide.

5Lines of credit, promo plans and vehicle loans

The same principle applies to other kinds of borrowing, with a few twists.

• Business line of credit: draws increase the liability, repayments reduce it, and the monthly interest charge goes to interest expense. Reconcile it like a bank account, because the balance moves often.
• 0% promotional financing: if a plan charges no interest during a promo period and you pay it off in time, every payment is pure principal. If the promo lapses and deferred interest is charged, book that interest to expense in the month it appears on the statement.
• Fees: admin or account fees on a financing statement are generally deductible business expenses. Book them to bank charges or interest and fees, not to the liability.
• Vehicle loans: the vehicle goes on the balance sheet as an asset, the loan as a liability, and payments split exactly as in the example above. Leases are different, so don't set a lease up as a loan.

Whatever the product, the test is the same: does this payment reduce what I owe, or is it a cost of borrowing? Only the second one is an expense.

6The Canadian tax side

• Interest is generally deductible when the borrowed money was used to earn business income. It goes on your T2125 as a sole proprietor or your T2 as a corporation.
• Principal is not deductible. Instead, the asset you bought is claimed over time through CCA, using the asset's class.
• No GST on interest or principal. Lending is generally an exempt financial service. Your GST credit came from the purchase itself.
• Mixed-use borrowing. If part of a loan paid for something personal, only the business share of the interest is usually deductible. Your accountant can help you work out the split.
• Vehicle loans have their own limit on deductible interest for passenger vehicles. Check CRA's current figure or ask your accountant before you buy.

7Common loan payment mistakes

1. Expensing the whole payment

Booking $559.75 a month to "Loan payments" expense overstates expenses by $6,300 over the year. Your profit looks lower than it is, your tax return is wrong, and the loan never shows on your balance sheet.

2. Never recording the loan

If the original purchase wasn't recorded, the loan account starts at zero and every principal payment pushes it negative. A negative loan balance is a clear sign the opening entry is missing.

3. Using one fixed split forever

Copying month one's split into every month means interest is overstated and the loan balance won't reach zero when the loan is paid off.

4. Claiming GST on the payment

The monthly payment has no GST in it. Claiming 5% of each payment as an input tax credit is a mistake CRA will reverse.

5. Not reconciling the loan

Your books and the lender should agree on what you owe. If they don't, a payment, fee or interest charge is missing.

8Monthly loan checklist

Plum sets up loans, equipment financing and vehicle loans properly for businesses across Edmonton, Sherwood Park, St. Albert and Spruce Grove, and reconciles them every month. If your loan payments have been going to expense, book a call and we'll get them sorted before year end.

9Questions people ask

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This article is general information for Alberta businesses and isn't tax or legal advice. Rules and thresholds change, so confirm your situation with your accountant or CRA.