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Recording loan payments: interest and principal in your books

A monthly loan payment leaves your bank account as a single amount, but it is two different things. One part is interest, which is a cost of borrowing. The other part is principal, which reduces what you owe and is not an expense. Recording the whole payment as an expense overstates costs and leaves a liability on the balance sheet that never shrinks. This article explains how to set up the loan, split each payment, treat fees and equipment loans, and reconcile to the lender. It is general information, not advice on your own loan.

Sora Accounting & Tax · General information · Editorial policy
Updated · 6 min read

One loan payment, two entries in your books

A single loan payment splits into an interest expense and a reduction of the loan liability, then reconciles to the lender.

Visual labels: Interest expense; Principal reduces debt; Balance matches lender.

What to take away

  • Record the loan as a liability when the money arrives, and split each payment between interest and principal.
  • Interest on money borrowed for business is generally deductible; the principal part of a payment is not an expense.
  • Check the loan balance in your books against the lender’s statement every month or at least every quarter.

A loan payment is two transactions

When a lender advances money, your bank balance rises, but you have not earned anything. The matching entry is a liability: you now owe the lender. Each payment then does two jobs. The interest part is the price of using the money for that period, and it goes to an interest expense account. The principal part pays down the debt and reduces the liability.

If the whole payment is coded to interest or to a general expense, profit looks lower than it really is, and the balance sheet keeps showing the original debt. If the whole payment is coded against the loan, profit looks higher than it should because the interest cost has been left out. Both errors compound each month until someone compares the books with the lender.

Set up the loan before the first payment

Create a liability account for each loan, named so you can recognize it, such as the lender and the purpose. Record the advance on the date funds arrive, using the loan agreement and the bank deposit. If the loan paid a supplier directly, as equipment financing sometimes does, the money may never touch your bank account, so you need the lender’s paperwork to record it.

Keep the agreement, the payment schedule and any fee statements together. The schedule shows the payment amount, the dates and usually the split between interest and principal. Without it, you can ask the lender for an amortization schedule or a payment history. Do not estimate when the lender can give you the actual figures.

How to split a payment

Use the lender’s statement or schedule to find the interest part of each payment. Record the interest to the expense account and the rest to the loan liability. Many accounting programs let you enter a single bank transaction as a split across two accounts, which keeps the entry tied to the bank line.

Here is an illustrative example with round numbers. A $10,000 loan at an annual rate of 6% has a monthly interest cost of about $50 on the opening balance. If the payment is $500, about $50 is interest and about $450 reduces the loan to roughly $9,550. Next month the interest is lower, about $48, so slightly more of the same payment goes to principal. Real loans can calculate interest differently, so rely on your lender’s figures rather than this arithmetic.

What is deductible and what is not

The CRA says you can deduct interest on money borrowed for business purposes or to acquire property for business purposes. It also says you cannot deduct the principal part of loan or mortgage payments, and you should not deduct interest on money borrowed for personal purposes. That is why the split matters for the tax return, not just for tidy books.

There are limits, including a cap on interest for some passenger vehicles and for vacant land. Our article on deducting interest on business loans covers the purpose test and the limits. Your books should record the interest accurately, and your accountant decides what is claimed.

Loan fees, penalties and prepayments

Fees paid to the lender do not always belong in the interest account, so code them separately. According to the CRA, certain fees to get a loan for business property, such as application, appraisal, processing and insurance fees, or legal fees related to financing, are deducted over five years at 20% a year, not all at once. If you repay the loan early, the remaining fees can be deducted at that point.

A fee to reduce your interest rate, or a penalty to pay off a loan early, is treated as prepaid interest and deducted over the remaining original term. Record these in a prepaid account or flag them for your accountant rather than expensing them on the day you pay. Standby charges and similar fees that relate only to one year may be deductible in that year. Our article on deducting interest on business loans covers the tax side in more detail; here the point is to keep each fee identifiable in your books.

Equipment and vehicle loans

When a loan buys equipment, two separate things happen in your books. The asset is recorded at its cost, and the loan is recorded as a liability. The asset is not expensed when you buy it, and the loan payments do not become the asset’s cost. The CRA states you cannot claim expenses you incur to buy capital property; the cost is generally recovered through capital cost allowance instead.

The CRA also says you can choose to capitalize interest on money borrowed to buy depreciable property, adding it to the property’s cost instead of deducting it. That is a tax choice, so ask before you code the interest. Keep the purchase invoice, the loan agreement and a note of when the asset was ready for use.

Lines of credit, cards and owner loans

A line of credit works like a loan with no fixed schedule. Draws increase the liability, repayments reduce it, and interest is charged separately, usually on the statement. Code each of those three items on its own. If a line of credit funds both business and personal spending, only the business-purpose interest is generally deductible, so keep the draws traceable.

Money an owner lends to the business is also a loan, but it belongs in an owner’s loan account, not a bank loan account. Our article on recording owner contributions and withdrawals explains that separation. If a corporation lends money to an owner, different tax rules apply, covered in our article on avoiding shareholder loan income inclusion.

Reconcile to the lender and bring the right records

After you record each payment, compare your loan balance with the lender’s statement. A small difference can come from timing, such as interest accrued but not yet paid at month-end. At year-end, record interest that has built up but not been paid, and separate the part of the balance due within twelve months from the part due later, since long-term liabilities are those payable beyond 12 months.

For your accountant, bring the loan agreement, the year-end lender statement showing interest paid and the closing balance, fee statements, and any renewal or refinancing documents. A refinancing can change the interest, fees and the loan balance in ways that are hard to reconstruct later.

Sources & editorial notes

Sources checked October 24, 2026. The examples are illustrative and provide general information. Discuss how the guidance applies to your circumstances with your accountant.

Rules and guidance can change. Use the current official source and confirm the treatment for your facts. To flag an error, contact Sora.