Loan Payable

A loan payable is a borrower’s liability for money it has borrowed and not yet repaid, owed to a lender under a loan agreement. The balance is the principal still outstanding, not the principal plus the interest still to come, and it stands whether or not the borrower signed a negotiable promissory note for the debt. The plural form, loans payable, names the same liability on a balance sheet carrying more than one borrowing.

Why the Account Carries a Credit Balance

Borrowing does not make a business richer or poorer on the day the money arrives. Cash goes up and an obligation goes up with it, so nothing reaches the income statement. The tax answer runs the same way, since money borrowed through a bona fide loan is not income (IRS, Publication 334).

Because nothing was earned when the money arrived, nothing is spent when it goes back. The borrowing is recorded as a liability and the repayment of principal removes that liability, so neither leg touches the income statement. Drawing the money debits cash and credits loan payable, and the account then behaves like every other liability, where a credit increases the balance and a debit reduces it, the rule set out in debit vs credit.

Whether the same balance is also reported as a note payable turns on the document behind it. UCC Article 3 fixes those labels for its own purposes: an instrument there means a negotiable instrument (UCC 3-104(b)), such an instrument is a note if it is a promise (UCC 3-104(e)), and a promise is a written undertaking to pay money signed by the person undertaking to pay (UCC 3-103(a)(12)). What the signed document does to the ledger is worked through in accounts payable and notes payable and, for the bank case, in bank notes payable.

How Each Payment Splits

A scheduled loan payment does two separate things at once. The principal portion reduces the carrying balance of the loan payable. The interest portion pays for the time the money was outstanding and belongs to the period it ran in. Except as otherwise provided in sections 264 to 267, inclusive, interest paid or accrued within the taxable year on indebtedness is allowed as a deduction in computing taxable income (Treasury Regulation 1.163-1(a)), and how far that deduction actually reaches is worked through in cost of capital. Interest incurred while an asset is being readied for its intended use is treated differently, and that case is in capitalized interest.

The carrying balance is principal outstanding, not interest that has not yet run. Future interest is not owed until time passes, so it does not sit inside the loan. Interest that has already run between payment dates is tracked apart from the loan, and Regulation S-X lists accrued interest among the items a filed balance sheet states separately, on its face or in a note, once one of them exceeds 5 percent of total current liabilities (17 CFR 210.5-02). The day count that fixes how much has run is in accrued interest.

How One Loan Splits Across Two Lines

A single loan usually occupies two lines. The slice of principal due inside the next year is normally reported in the current block and the rest is not, and because the schedule keeps moving, that split is recut at each close instead of being settled when the loan is signed. What draws that line is set out in current liabilities, and the remainder is the subject of long-term liabilities. A breach of a loan covenant can move the whole balance into the current block whatever the repayment schedule says.

Say a client draws a loan and repays principal in equal monthly amounts.

Loan drawn                                       120,000
  Debit  Cash                                    120,000
  Credit Loan payable                            120,000

First month, stated rate 9% a year
  120,000 x 9% x 1/12                     =          900
Payment made                                       2,900
  Debit  Loan payable, principal                   2,000
  Debit  Interest expense                            900
  Credit Cash                                      2,900
  Loan payable after the payment                 118,000

Twelve payments in, at the balance sheet date
  Principal outstanding                           96,000
  Principal scheduled for the next 12 months      24,000
  Current portion                                 24,000
  Noncurrent remainder                            72,000

Interest never enters the loan payable balance, and the reclassification at the reporting date pays nothing down.

Where a Loan Payable Sits on a Return

Neither the corporate nor the partnership balance sheet per books carries a line called loan payable. The corporate return splits the same balances by maturity and gives loans from shareholders a line of its own, set out in liabilities. A partnership return puts loans from partners or persons related to partners on line 19a inside the liability block (IRS, Form 1065, Schedule L), covered in owner’s equity.

That return also carries a line the corporate one has no equivalent for, all nonrecourse loans at line 18 (IRS, Form 1065, Schedule L). What puts a borrowing on that line rather than beside the rest is in recourse.

Those lines are where loans payable most often go wrong in a small client’s books. An advance from a partner or a shareholder posted to equity, or swept into other liabilities, leaves the return saying something the loan documents do not. The amount reported is the balance per books at year end, so a client that expensed the whole monthly payment instead of splitting it reports a liability that will not tie to the lender’s payoff statement.

Common Questions

Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a firm can put a block of its own debt schedules and loan reconciliations through a trial task before anything client facing depends on it.