How Bookkeepers Handle Short-Term Debt - dummies

How Bookkeepers Handle Short-Term Debt

By Consumer Dummies

Any money due in the next 12-month period is shown on the balance sheet as short-term or current debt. Any interest paid on that money is shown as an Interest Expense on the income statement.

In most cases, you don’t have to calculate your interest due. The financial institution sending you a bill gives you a breakdown of the principal and interest to be paid.

How credit-card interest is calculated

For example, when you get a credit-card bill at home, a line always shows you new charges, the amount to pay in full to avoid all interest, and the amount of interest charged during the current period on any money not paid from the previous bill. If you don’t pay your credit in full, interest on most cards is calculated using a daily periodic rate of interest, which is compounded each day based on the unpaid balance.

Yes, credit cards are a type of compounded interest. When not paid in full, interest is calculated on the unpaid principal balance plus any unpaid interest. The following table shows what a typical interest calculation looks like on a credit card.

Credit-Card Interest Calculation
Avg. Daily Balance Daily Periodic Rate Corresponding Annual Rate Finance Charges Daily Rate Transaction Fees
Purchases $XXX 0.034076% 12.40% $XXX $XXX
Cash $XXX 0.0452% 16.49% $XXX $XXX

On many credit cards, you start paying interest on new purchases immediately, if you haven’t paid your balance due in full the previous month. When opening a credit-card account for your business, be sure you understand how interest is calculated and when the bank starts charging on new purchases. Some issuers give a grace period of 20 to 30 days before charging interest, while others don’t give any type of grace period at all.

In the table, the Finance Charges include the daily rate charged in interest based on the daily periodic rate plus any transaction fees. For example, if you take a cash advance from your credit card, many credit-card companies charge a transaction fee of 2 to 3 percent of the total amount of cash taken. This fee can be true when you transfer balances from one credit card to another.

Although the company entices you with an introductory rate of 1 or 2 percent to get you to transfer the balance, be sure to read the fine print. You may have to pay a 3 percent transaction fee on the full amount transferred, which makes the introductory rate much higher.

Using credit lines

As a small business owner, you get better interest rates using a line of credit with a bank rather than a credit card. Interest rates are usually lower on lines of credit. Typically, a business owner uses a credit card for purchases, but if he can’t pay the bill in full, he draws money from his line of credit rather than carry over the credit-card balance.

When the money is first received from the credit line, you record the cash receipt and the liability. Just to show you how this transaction works, record the receipt of a credit line of $1,500. Here is what the journal entry would look like to record receipt of cash from credit line:

Debit Credit
Cash 1,500
Credit Line Payable 1,500

In this entry, you increase the Cash account and the Credit Line Payable account balances. If you’re using a computerized accounting program, you record the transaction using the deposit form.

When you make your first payment, you must record the use of cash, the amount paid on the principal of the loan, and the amount paid in interest. Here is what that journal entry looks like to make monthly payment on credit line:

Debit Credit
Credit Line Payable 150
Interest Expense 10
Cash 160

This journal entry reduces the amount due in the Credit Line Payable account, increases the amount paid in the Interest Expense account, and reduces the amount in the Cash account.

If you’re using a computerized system, you simply complete a check form and indicate which accounts are impacted by the payment, and the system updates the accounts automatically.