Recording Short-Term Debt Transactions for Your Business
Most businesses borrow money for both short-term periods (periods of one year or less) and long-term periods (periods of more than one year). Short-term debt usually involves some form of credit-card debt or line-of-credit debt.
Any money due in the next 12-month period is shown on the balance sheet as short-term or current debt. Any interest paid on that money is shown as an Interest Expense on the income statement. In most cases, you don’t have to calculate your interest due. The financial institution sending you a bill gives you a breakdown of the principal and interest to be paid.
How credit card interest is calculated
When you get a credit-card bill at home, a line always shows you new charges, the amount to pay in full to avoid all interest, and the amount of interest charged during the current period on any money not paid from the previous bill.
If you don’t pay your credit in full, interest on most cards is calculated using a daily periodic rate of interest, which is compounded each day based on the unpaid balance. The following table shows what a typical interest calculation looks like on a credit card.
|Avg. Daily Balance||Daily Periodic Rate||Corresponding Annual Rate||Finance Charges|
|Daily Rate||Transaction Fees|
When opening a credit-card account for your business, be sure you understand how interest is calculated and when the bank starts charging on new purchases. Some issuers give a grace period of 20 to 30 days before charging interest, while others don’t give any type of grace period at all.
In the preceding table, the Finance Charges include the daily rate charged in interest based on the daily periodic rate plus any transaction fees. For example, if you take a cash advance from your credit card, many credit-card companies charge a transaction fee of 2 to 3 percent of the total amount of cash taken.
This fee can be true when you transfer balances from one credit card to another. Although the company entices you with an introductory rate of 1 or 2 percent to get you to transfer the balance, be sure to read the fine print. You may have to pay a 3 percent transaction fee on the full amount transferred, which makes the introductory rate much higher.
Using credit lines
As a small business owner, you get better interest rates using a line of credit with a bank rather than a credit card. Interest rates are usually lower on lines of credit. Typically, a business owner uses a credit card for purchases, but if he can’t pay the bill in full, he draws money from his line of credit rather than carry over the credit-card balance.
When the money is first received from the credit line, you record the cash receipt and the liability. Here is what the journal entry would look like if you record the receipt of a credit line of $1,500:
|Credit Line Payable||$1,500|
|To record receipt of cash from credit line.|
In this entry, you increase the Cash account and the Credit Line Payable account balances. If you’re using a computerized accounting program, you record the transaction using the deposit form, as shown in the following figure.
When you make your first payment, you must record the use of cash, the amount paid on the principle of the loan, and the amount paid in interest. Here is what that journal entry looks like:
|Credit Line Payable||$150|
|To make monthly payment on credit line.|
This journal entry reduces the amount due in the Credit Line Payable account, increases the amount paid in the Interest Expense account, and reduces the amount in the Cash account.
If you’re using a computerized system, you simply complete a check form and indicate which accounts are impacted by the payment, and the system updates the accounts automatically. The next figure shows how to record a loan payment in QuickBooks.
As you can see in the preceding figure, at the same time that you prepare the check for printing, you can add the accounts that are impacted by that payment by splitting the detail expense information. QuickBooks can then print the check and update all affected accounts. You don’t need to do any additional postings to update your books.