Paid Interest on Loan Journal Entry

Interest is the cost of borrowing money, usually expressed as a percentage of the loan amount. It is the amount that the borrower pays to the lender in exchange for using the loan.

Interest is important because it allows lenders to compensate for the risk they are taking in lending money to the borrower. The higher the risk, the higher the interest rate the lender charges to the borrower. In some cases, lenders may require collateral to secure a loan and to reduce the risk. This collateral acts as a safety net in case borrowers are unable to repay the loan.

The amount of interest you pay will also depend on the type of loan you have. For example, secured loans typically have lower interest rates than unsecured loans because they are considered to be less risky. However, if you default on a secured loan, the lender may seize your collateral. In contrast, unsecured loans do not require collateral, but they often have higher interest rates.

Interest expense will be recorded when the company borrowed money and it has to pay periodic interest to the lender, based on the effective interest rate method. This accrual process is important because it matches the periodic expenses with the revenue earned during that period. The effective interest rate is the true cost of borrowing, considering the time value of money and compounding effects. It will be used to record the journal entries for all future interest payments. This will ensure that the financial statements accurately reflect the company’s financial position.

The interest expense will record on the company income statement. It is recorded based on the accrual basic not the cash paid. If the interest is due but not yet paid, so the company needs to record interest expense and interest payable.

Journal Entry for Interest paid on Loan

The interest is charged based on the loan principle, interest rate, and time period. The company needs to record the interest expense base on the occurrence which is the time period. So at the end of each month, company has to calculate the interest expense and record it on the income statement.

At the month end, the company makes journal entry of debiting interest expense and credit interest payable.

Account	Debit	Credit
Interest Expense	000
Interest Payable		000

When the company paid interest to the bank, it needs to reverse the interest payable and record cash paid. The journal entry is debiting interest payable and credit cash.

Account	Debit	Credit
Interest Payable	000
Cash		000

Example

Company ABC has borrowed loan $ 100,000 from the bank with an interest rate of 6%. The company is required to pay the interest on the 2nd of the next month. Please prepare journal entry for paid interest on loan.

The company is required to pay monthly interest expenses on the loan to the bank. Based on the loan schedule, the company pays on the 2nd day of next month. So the company needs to record interest expenses at month end and pay interest to bank after two days.

It means the company needs to record interest expense at the month end alongside interest payable. The journal entry is debiting interest expense $ 500 ($ 100,000*6%/12months) and credit interest payable $ 500.

Account	Debit	Credit
Interest Expense	500
Interest Payable		500

On the 2nd of next month, company has to pay the interest to the bank. It has to reverse the interest payable from the balance sheet.

The journal entry is debiting interest payable $ 500 and credit cash $ 500.

Account	Debit	Credit
Interest Payable	500
Cash		500