A loan or finance lease will include an element of interest. So the repayments of the loan or lease will comprise two elements, a repayment of part of the capital (i.e. the amount borrowed) and a payment of part of the interest charged.

There are basically two ways of recording the setting up of a loan or lease.

Method 1

1. The total amount of the loan and the total interest to be charged is credited to a new loan account in the range 2100 to 2199.
2. The amount of the loan is debited to the bank account (in the range 1200 to 1209) if the money is transferred into a bank account or is debited to the fixed asset account if the money is transferred directly to the supplier.
3. The total interest on the loan is then debited to a new account called Interest Suspense which will need to be set up in the range 1100 to 1199.
4. Each year (or period) an amount of interest is transferred by journal entry from the Interest Suspense account to an account in the Profit and Loss Account which will be called Loan Interest (usually in the range 7900 to 7999).

   This can be calculated in a number of different ways but unless the loan interest is a significant expense in the Profit and Loss Account the easiest way is to divide the total amount of the interest by the number of repayments. That will give you the interest charge for each repayment period (e.g. per month or per quarter).

5. When a repayment is made the total amount is posted to the loan account which was set up (in step 1 above) in the range 2100 to 2199.

Method 2

1. Only the amount of the loan is credited to a new loan account in the range 2100 to 2199. The interest element is ignored at this stage.
2. The amount of the loan is debited to the bank account (in the range 1200 to 1209) if the money is transferred into a bank account or is debited to the fixed asset account if the money is transferred directly to the supplier.
3. Each repayment amount is then split between a repayment of capital and a payment of interest.

   This can be calculated in a number of different ways but unless the loan interest is a significant expense in the Profit and Loss Account the easiest way is to divide the total amount of the interest by the number of repayments. That will give you the interest charge for each repayment period (e.g. per month or per quarter). The balance is the capital repayment element.

4. When a repayment is made then the amount representing the repayment of capital is posted to the loan account which was set up (in step 1 above) in the range 2100 to 2199. The amount representing the payment of interest is then posted to an account in the Profit and Loss Account which will be called Loan Interest (usually in the range 7900 to 7999).

Amounts owing over one year

The above methods both set up a new loan or finance lease account in the range 2100 to 2199 which will treat the loan as a current liability. However, when we prepare the year-end accounts we will then have to split the balance outstanding on the loan between the amount due within the next twelve months and the amount due after twelve months. This is a statutory disclosure requirement.

Finance Leases and Operating Leases

The basic difference between a finance lease and an operating lease is that a finance lease is tantamount to a loan, where you borrow a sum of money in order to purchase an asset and then pay off the loan regardless of whether that asset is scrapped or disposed of in the meantime. An operating lease is the straightforward rental of an asset over a given period. When the period ends you hand the asset back to the owner or you may have an option to purchase the asset at a predetermined price at that stage.

The area of leases can be quite complicated and finance companies often offer a wide range of products which can be confusing. For the correct accounting treatment of any lease please contact us on 01903 600555 or email us on info@wmadvice.co.uk