{m}.{s}.1Bank overdraft

A business with an agreed overdraft limit may simply purchase an asset by cheque, thus increasing its overdraft.

Double entry will simply be:

  • Debit Asset account
  • Debit VAT (if appropriate)
  • Credit Bank

Interest will be charged by the bank on the overdraft. This will be included on the bank statement, usually monthly or quarterly. The double entry in the books is:

  • Debit Bank interest
  • Credit Bank

Interest is charged in arrears and is calculated exactly by the bank on the day-to-day overdrawn balance.

Thus at the year end there will usually be an accrual required for bank interest (and charges) from the last charging point to the year end. This figure can be estimated or the exact figure can be obtained from the bank.

Note that debits and credits are apparently reversed on the bank statement. (See Bank reconciliations).

Current account
2008   Withdrawn Paid in Balance
June 1 Balance b/f     5,240 o/d
June 1 546240 9,900   15,140 o/d
Jun 10 Interest to 31 May 32   15,172 o/d
[{m}.{s}a]

{m}.{s}.2Bank loan

If long-term finance is required for a business, it is better to procure this in the form of a loan rather than as an overdraft. This may be a general loan to finance a business, or it may be for a specific purpose such as the purchase of an asset.

A separate account will be opened by the bank and a separate account will need to be opened in the books of the business - Bank loan.

Repayments of the capital amount will be agreed at the outset. This will often be in the form of a monthly transfer from the current account to the loan account.

Interest will be charged, usually quarterly, in arrears on the actual amount outstanding. This may be added to the balance of the loan, or charged separately in the current account.

 

Loan account
2008   Withdrawn Paid in Balance
June 3 Payment 9,900   9,900 o/d
June 30 Transfer from current account   250 9,650 o/d
[{m}.{s}b]

{m}.{s}.3Bank loan: Example

On 30 May 2008 Mr Waterman purchased new office premises for his plumbing business for £20,000. He obtains a bank loan of £15,000 to assist with this purchase. The balance has been paid from the funds in his current account. (There was no VAT on these premises).

Repayments are being made monthly by transfer of £325 from his current account to the loan account, commencing 30 June. Interest is added quarterly by the bank to the loan account.

We will now record these transactions in Mr Waterman's books.

 

Loan account
2008   Withdrawn Paid in Balance
May 30 Advanced 15,000   15,000 o/d
June 30 Transfer from account 624326   325 14,675o/d
[{m}.{s}c]

{m}.{s}.4

Step 1: Original loan

The first step will be to open a Bank loan account.

30 May: The premises are purchased for £20,000. This has been paid - £5,000 from the current account and £15,000 from the loan account.

Loan account
2008   Withdrawn Paid in Balance
May 30 Advanced 15,000   15,000 o/d
[{m}.{s}d]
[{m}.{s}e]

 

Step 2: First repayment

The first repayment of £325 is made from the current account at the end of June.

Loan account
2008   Withdrawn Paid in Balance
May 30 Advanced 15,000   15,000 o/d
June 30 Transfer (Current account)   325 14,675o/d
[{m}.{s}f]
[{m}.{s}g]

 

Step 3: Further repayments

Further repayments are made at the end of July and August.

Loan account
2008   Withdrawn Paid in Balance
May 30 Advanced 15,000   15,000 o/d
June 30 Transfer (Current account)   325 14,675o/d
July 31 Transfer (Current account)   325 14,350o/d
Aug 31 Transfer (Current account)   325 14,025o/d
[{m}.{s}h]
Bank Loan
30 Jun Bank32530 May Prop'ty15,000
31 Jul Bank325    
31 Aug Bank325    
      
      
[{m}.{s}i]

 

Step 4

Interest is charged by the bank on 31 August. £522 is added to the loan account balance. (Note that no VAT is charged on bank interest).

Loan account
2008   Withdrawn Paid in Balance
May 30 Advanced 15,000   15,000 o/d
June 30 Transfer (Current account)   325 14,675o/d
July 31 Transfer (Current account)   325 14,350o/d
Aug 31 Transfer (Current account)   325 14,025o/d
Aug 31 Interest to Aug 25 522   14,574o/d
[{m}.{s}j]
[{m}.{s}k]

 

Step 5: September payment

The last repayment before the year end is made in September.

Loan account
2008   Withdrawn Paid in Balance
May 30 Advanced 15,000   15,000 o/d
June 30 Transfer (Current account)   325 14,675o/d
July 31 Transfer (Current account)   325 14,350o/d
Aug 31 Transfer (Current account)   325 14,025o/d
Aug 31 Interest to Aug 25 522   14,574o/d
Sept 30 Transfer (Current account)   325 14,222o/d
[{m}.{s}l]
Bank Loan
30 Jun Bank32530 May Prop'ty15,000
31 Jul Bank325 31 Aug Interest 522
31 Aug Bank325    
30 Sep Bank325   
      
[{m}.{s}m]

 

 

Step 6: Accrued interest

Before preparing the accounts to 30 September 2008, accrued interest must be considered.

This figure is obtained from the bank - interest accrued for the period 26 August and 30 September is £169. This does not affect the actual loan account - it is recorded as an accrual.

Loan account
2008   Withdrawn Paid in Balance
May 30 Advanced 15,000   15,000 o/d
June 30 Transfer (Current account)   325 14,675o/d
July 31 Transfer (Current account)   325 14,350o/d
Aug 31 Transfer (Current account)   325 14,025o/d
Aug 31 Interest to Aug 25 522   14,574o/d
Sept 30 Transfer (Current account)   325 14,222o/d
[{m}.{s}n]
Bank Loan
30 Jun Bank32530 May Prop'ty15,000
31 Jul Bank325 31 Aug Interest 522
31 Aug Bank325    
30 Sep Bank325   
      

2008   Dr Cr
30 Sept Bank interest 169  
  Accruals   169
Closing accrual of bank interest
[{m}.{s}o]

 

 

 

Step 7: Year end

The Bank loan account will be balanced off for inclusion as a liability in the balance sheet.

Note that the balance agrees with the balance showing on the bank statement for the loan account.

Note that the monthly repayment of £325 is not just a repayment of the £15,000. This payment covers interest as well. We do not at the time however have to split this out between interest and capital - this works out "automatically" as interest gets credited to the account (and debited to the interest expense account).

The capital balance has been reduced over the period by
15000 - 14222 = 778
(= 4 x 325 - 522)

Loan account
2008   Withdrawn Paid in Balance
May 30 Advanced 15,000   15,000 o/d
June 30 Transfer (Current account)   325 14,675o/d
July 31 Transfer (Current account)   325 14,350o/d
Aug 31 Transfer (Current account)   325 14,025o/d
Aug 31 Interest to Aug 25 522   14,574o/d
Sept 30 Transfer (Current account)   325 14,222o/d
[{m}.{s}p]
Bank Loan
30 Jun Bank32530 May Prop'ty15,000
31 Jul Bank325 31 Aug Interest 522
31 Aug Bank325    
30 Sep Bank325   
      

[{m}.{s}q]