Interest payments are made by Accounts Payable. It is one of the most complicated types of payments to record. The complication arises when calculating the interest expenses. When calculating loan repayment, the payment allocated to the principal portion to pay down the loan account (a liability) is separate from the interest portion to track the expenses related to the loan in the “Interest Expense “account. A payoff of loan principal reduces the liability section of the balance sheet and a payment of interest increase the expense section of the profit & loss statement. Remember if the loan payment is late, additional interest is charged and needs to be accounted for.
This is calculated on the principal sum, not compounded on earned interest. It computes the interest costs of a loan based solely on the loan principal. Record the amount paid on the principal under “Loan Payable” while recording separately the interest paid under “Interest Expense.” This is a rare form of loan today because most companies prefer to reduce their interest expenses by paying down the principal early.
This is calculated not only on the initial principal but also on the accumulated interest of prior periods. An example of a compound interest interest loan is a home mortgage loan. A compound interest loan is entered in the same format as a simple interest loan. However, the amount allocated to principal and interest is different. The breakdown may be noted in a monthly statement sent by the bank. Or the bank my provide an amortization schedule indicating the amounts.