In accounting, a bank loan is a type of financial transaction where a borrower borrows funds from a bank or other financial institution, typically for a specific purpose, with the promise to repay the borrowed amount plus interest over a fixed period of time. Bank loans are a common source of financing for businesses and individuals, as they provide a convenient and often lower-cost alternative to other forms of borrowing, such as credit cards or personal loans. Today, I will explain What is bank loan in accounting?

When a bank loan is taken out, there are several accounting considerations that must be taken into account. These include the initial recognition of the loan, subsequent measurement, and eventual repayment. In this article, we will discuss these accounting considerations in detail, along with the related journal entries.

Recognition of the Bank Loan

The initial recognition of a bank loan is the process of recording the loan in the borrower’s financial statements. This involves recognizing the amount borrowed as a liability on the balance sheet and recognizing the funds received as cash or other assets. The amount of the liability recognized is equal to the amount borrowed, and it is recorded as a current or long-term liability depending on the repayment terms.

For example, assume that a company borrows $100,000 from a bank with a repayment period of three years. The company receives $100,000 in cash and records a liability for the same amount on its balance sheet. If the loan has a repayment period of less than one year, it would be recorded as a current liability. If the loan has a repayment period of more than one year, it would be recorded as a long-term liability.

Journal Entry: Cash…………………………………….. 100,000 Bank Loan……………………………….. 100,000

Subsequent Measurement

Once a bank loan has been recognized, it must be measured and recorded at each reporting period until it is repaid in full. The measurement of the loan includes the recognition of any interest expense, which is the cost of borrowing the funds. Interest expense is calculated based on the loan’s interest rate and the outstanding balance of the loan.

For example, if a company borrows $100,000 from a bank at an interest rate of 5% per year, the interest expense for the first year would be $5,000 ($100,000 x 5%). If the loan is repaid over three years, the interest expense would be calculated and recorded for each year until the loan is fully repaid.

Journal Entry: Interest Expense……………………………. 5,000 Interest Payable…………………………….. 5,000

Note: Interest payable is a current liability account representing the amount of interest owed but not yet paid.

Repayment of the Bank Loan

The repayment of a bank loan involves the reduction of the loan liability over time until it is fully repaid. Each payment made towards the loan includes both a portion of the principal amount borrowed and interest expense. The principal portion of the payment reduces the loan balance, while the interest expense is recognized as an expense in the income statement.

For example, assume that a company borrows $100,000 from a bank with a repayment period of three years and a monthly payment of $3,000. The first monthly payment would include interest expense of $417 ($100,000 x 5% / 12) and a principal repayment of $2,583 ($3,000 – $417). The loan liability would be reduced by $2,583, and the interest expense would be recognized in the income statement.

Journal Entry: Interest Expense……………………………. 417 Bank Loan…………………………………. 2,583 Cash………………………………………… 3,000

The journal entry above shows the recognition of interest expense, the reduction of the loan liability, and the payment of cash.

Conclusion

In accounting, a bank loan is a type of financing transaction that involves borrowing funds from a bank or