Borrowing to acquire fixed assets is a widespread practice among small businesses, but it gets confusing when the business doesn’t account for the entire cost when it makes the purchase, but instead accounts for much of it when paying back the loan used to buy the assets.
In fact, companies are considered to have paid the full cost for an asset even if they take on debt to buy it. When a fixed asset is acquired, the bookkeeping process requires a journal entry.
An asset account on one side of the balance sheet is increased for the entire cost. On the other side is the addition of a note payable for the funds borrowed to buy the asset. A down payment made with company funds is the difference between asset cost and loan amount. This reduction in the cash asset balances the journal entry.
How it works
For example, consider a $10,000 equipment purchase that’s paid by $2,000 of company cash and $8,000 of borrowed money. A journal entry increases equipment assets (a $10,000 debit) while decreasing cash asset (a $2,000 credit) as well as increasing notes payable (an $8,000 credit).
Sometimes, owners are confused about where to account for their expenditures on loan payments. However, after accounting for the portion that is interest expense, each loan payment is simply applied to the note payable liability.
The takeaway: Loan principal is neither an expense nor an addition to the asset. Rather, the full cost of the asset was already recorded upon purchase. Easy!