Many times you must have observed that in the Trial Balance loan is recorded either on the credit side or on the debit side. If it appears on the credit side, then it implies that the loan is taken by the proprietor from its outsiders such as banks, financial institutions, etc. On the other hand, if the loan appears on the debit side of the Trial Balance, then it implies that the proprietor has granted a loan to the other parties (or to the outsiders). A loan taken by the proprietor is a liability for the business and thus interest on such a loan is considered as an expense. Whereas, a loan granted by the proprietor is an asset for the business and thus interest on such loan is considered as an income. Thus, the accounting treatment of interest loans in the books depends on whether the given loan is a loan taken or a loan granted.
When interest on a loan is given outside the trial balance
Accounting Treatment- The treatment of interest on loans in the final accounts is given below.
Treatment of Interest on Loan
|Treatment of Interest on Loan Taken||Treatment of Interest on Loan Granted|
|Firstly, interest on loans taken is shown on the Debit side of the Profit and Loss Account.||Firstly, interest on a loan granted is shown on the Credit side of the Profit and Loss Account.|
|Secondly, it is added to the amount of loan taken on the Liabilities Side of the Balance Sheet.||Secondly, it is added to the amount of loan granted on the Assets Side of the Balance Sheet.|
When Interest on Loan is given Inside the Trial Balance
There may be a situation when the interest on a loan is given inside the Trial Balance. In such a case, the loan amount (whether taken or granted) in the Trial Balance is shown after adding such interest on a loan. Therefore, there is no need to add this interest again to the amount of loan in the Balance Sheet. It is shown only in the Profit and Loss Account.
Interest on Capital
Any interest paid on capital is considered as an expense and is shown in the Profit and Loss Account. Treatment of interest on capital in the final accounts is as follows.
Interest on Drawings
Treatment of interest on drawings in the final accounts is as follows. Firstly, interest in drawings is shown on the credit side of the Profit and Loss Account.
What is Operating Profit?
Operating Profit can be defined as the profit earned by carrying the normal business activities. It is computed by subtracting the operating expenses from the gross profit.
The balance sheet is the last financial statement that is prepared by any organization. This statement helps to ascertain the true financial position of an enterprise at the end of an accounting period
Profit and Loss Account
A profit and Loss Account is the second financial statement prepared by an organization. This account is prepared to ascertain the net results of a firm in form of net profit earned or net loss incurred during an accounting period.
What are Adjusting Entries?
In order to incorporate adjustments in the financial statements, we pass the required Journal entries, which are termed as adjusting entries.