How would you record a loan repayment that includes both principal and interest, and how does it affect accounts?

• A. Use a journal entry: debit Cash for the principal, credit Liability for the principal.
• B. Use a journal entry: debit Liability (loan) for principal, debit or credit Interest Expense, and offset cash or bank account accordingly.
• C. Record the payment as a single expense.
• D. Record the payment as a loan receipt rather than a payment.

Answer: (B)

When you record a loan payment that includes both principal and interest, you must separate the two components and show how they affect different accounts. The principal portion reduces the liability you owe on the loan, while the interest portion is an expense representing the cost of borrowing. The cash account decreases by the total payment.

So you would record a journal entry that debits the loan payable for the principal portion and debits the Interest Expense for the interest portion, then credits Cash for the total amount paid. This shows the loan balance going down, the interest expense being recognized, and the cash outflow.

This approach is best because it accurately reflects both the reduction of debt and the cost of borrowing. Recording the payment as a single expense would wrongly treat the principal as an expense, and recording it as a loan receipt would misclassify a payment as if you were receiving money instead of paying it.