Borrowing to acquire fixed assets is a widespread practice of small businesses but accounting for these situations is frequently surrounded by confusion. Asset purchases are obscured when the business doesn’t pay the entire cost upon acquisition, but instead remits much of the cost when repaying a loan incurred to buy the asset.
Substantial bookkeeping enlightenment arises when business owners comprehend that their companies are considered to have paid the full cost for an asset regardless of incurring debt for the required purchase funds. When a fixed asset – such as equipment – 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. Any 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.
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 (a $8,000 credit).
Unfortunately, this firestorm of knowledge promotes a spark of complexity. That is, the question arises of where the loan payments appear as expenditures. In fact, each loan payment is applied to the note payable liability – after accounting for the portion that’s interest expense. Loan principal is neither an expense nor an addition to the asset. Rather, the full cost of the asset was already recorded upon purchase.
The Finance Writer 