Set up the loan when it starts
Create a liability account for each loan. Record the proceeds as a deposit to the bank and a credit to the loan account, not as income. Save the signed note, the amortization schedule, the closing statement and the lender's contact details. Note the interest rate, the term, the payment amount and due date, and any collateral or personal guaranty.
Record loan fees separately. Some are spread over the life of the loan, so ask your preparer how to treat them.
Split each payment
Every payment contains interest and principal. The lender statement or amortization schedule shows the split. Record the interest in an interest expense account and the principal as a reduction of the loan liability. Many accounting programs let you set up a recurring entry or a bank rule with a split. Review it after the first few payments.
Late fees and penalties go to their own account. They are not interest.
Reconcile to the lender's statement
At least quarterly, compare the loan balance in your books to the statement. They should agree to the cent. If they do not, find the missed or duplicated payment, an unrecorded fee or a rate change. Request a payoff letter or year-end statement every January, which shows interest paid for the year.
The preparer will ask for this annual interest figure. Having it ready speeds the return.
Understand covenants
Many commercial loans include promises called covenants, for example keeping a minimum cash balance, maintaining certain ratios, providing financial statements on a schedule or carrying insurance. Read the loan agreement and list each requirement with its due date. Breaking a covenant can allow the lender to demand repayment.
Your books are how you prove compliance, so create a report that shows the covenant measure each quarter.
Owner and related-party loans
Money lent by an owner or a relative should be documented with a written note stating the amount, terms and repayment plan. Record it as a loan, not as capital, if that is the intent, and keep a payment log. Loans to owners from the business also need paper and clear records. The tax effects of these loans can be significant, so involve your advisor.
Never record an owner loan only because the bank balance needed to be fixed.
Refinancing and payoffs
When a loan is refinanced or paid off, record the payoff amount, the interest to the date, and any fees and prepayment charges. Get a letter confirming a zero balance and keep it permanently. If a lien was filed, confirm that it was released.
A final tip concerns timing. Set payment reminders a few days before each due date and record the payment on the day it posts, not weeks later. Late fees often start with a missed reminder, and a lender that sees a pattern of on-time payments is easier to work with when you later ask for a new loan or a covenant waiver.
Common questions
Should I record the loan payment from the bank feed as a transfer?
Record it as a split transaction between interest expense and the loan liability. A plain expense or transfer misstates the books.
How do credit lines differ?
Draws increase the liability and repayments decrease it, with interest recorded as expense. Statements show the details.
Where do I find the interest paid for the year?
On the lender's year-end statement or a tax form the lender sends, which you should compare with your books.
This guide is general information, not tax, legal or accounting advice. Rules, fees and due dates change; check with the IRS, the NJ Division of Taxation or a licensed professional for your situation.