Debt capital is money invested in a company that does not belong to the company itself and must be repaid. In other words, it is someone else’s money – plain and simple, usually just debt.

Debt capital is divided into two categories: short-term and long-term. Short-term debt must be repaid within one year, while long-term debt has a repayment period extending beyond one year. So, if a loan or installment plan exceeds one year, it is considered long-term debt capital.

Long-term loans in accounting

Most often, a long-term loan in accounting is a bank loan or an instalment debt. Taking out a loan or repaying its principal does not affect the company’s profit, as these entries appear only on the balance sheet. However, expenses and interest related to the loan repayment are recorded in the income statement and reduce the financial year’s result.

It’s best to create a separate account in the balance sheet’s long-term liabilities section for each loan. The account can be named using the loan number or another clear identifier – for example, if a company acquires a car through instalments, the liability account could be named after the car’s make or license plate. Clear naming makes it easier to read the balance sheet and match repayments to the correct loan, especially if there are multiple loans or instalment agreements.

Bank loan in accounting

  The bank loan is recorded as a debit to the bank account, any start-up costs are recorded as a debit to the financial expenses on the income statement, and the credit entry is recorded as a new liability account on the balance sheet.

The loan repayment is recorded as a reduction of the loan account. This means that the repayment amount is entered in the debit side of the loan account, while any interest and fees are recorded in the debit side of their respective expense accounts in the income statement. The credit entry is made to the bank account (or whichever account the repayment was made from).

In this example, the loan balance has decreased by 250€, and when checking the loan account, the remaining balance (20,000€ – 250€ = 19,750€) matches the principal amount stated as outstanding after the repayment.

Instalment purchase

An instalment purchase is a payment method where the price of a product or service is paid to the seller in pre-agreed instalments. If the repayment period exceeds one year, it is considered long-term liabilities. Instalment purchases may involve value-added tax (VAT), which must be taken into account when making bookkeeping entries. If the buyer signs the instalment agreement directly with the seller, any loan arrangement fees may be subject to VAT. On the other hand, if there is a financing company involved and the buyer signs the agreement with them, these fees are generally VAT-exempt. Usually, the VAT for an instalment purchase is deducted in full at once, and no VAT is involved in the subsequent instalment repayments (though it is important to check whether the monthly financing costs include VAT).

Instalment purchase in accounting

For example, if you buy a car on instalments, the entry would be as follows:

• The purchase price of the car = The price excluding VAT goes to the company’s assets, i.e. the debit of the machinery and equipment account, the value-added tax goes to the debit of VAT receivables and the entire purchase price excluding VAT goes to the credit of the instalment debt.

• Credit establishment fee = VAT-free price to debit finance expense in the income statement, VAT to debit VAT receivables and VAT-inclusive price to credit instalment debt.

• Down payment = Bank account to the credit and instalment debt to the debit, to reduce the amount of debt.

The instalment payment would look like this:

Instalment repayment = Recorded as a debit to the instalment liability account to reduce the debt, and a credit entry to the bank account, since the repayment was made from there.

Monthly costs = In this case, the monthly costs include VAT, so the net amount goes to the income statement under financial expenses, the VAT portion to the debit of VAT receivables, and the gross amount to the credit of the bank account.

We can again note that the balance of the car instalment account (49,400 – 500 = 48,900 euros) matches the outstanding principal shown on the invoice.

Reconciliation of long-term loans

It’s important to reconcile long-term loans regularly to ensure the liability account in the accounting records matches the actual debt. Sometimes, an accountant might mistakenly record the entire repayment as a reduction of the loan, even though part of it includes interest and fees. This would cause the loan balance in the books to drop faster than in reality, giving incorrect information. Regular reconciliation – even monthly – can save a lot of trouble at year-end.