The installment note journal entry, step by step
Businesses often borrow for equipment, vehicles or property with a note that is repaid in regular installments. Each payment does two jobs at once: it pays the interest owed for the period, and it repays part of the amount borrowed. The bookkeeping skill is splitting every payment correctly between the two. This page explains how, works through four examples and covers the mistakes our exercises catch most often.
What an installment note is
A note payable is a written promise to repay borrowed money, usually with interest. An installment note is repaid in a series of payments over its life, instead of in one lump sum at the end. The amount originally borrowed is the principal.
When the business borrows, it records the cash it receives and the liability it now owes:
| Account | Debit | Credit |
|---|---|---|
| Cash | $100,000.00 | |
| Notes Payable | $100,000.00 |
Notes Payable is a liability with a normal credit balance. Each payment reduces it by the principal portion, until it reaches zero at the end of the note.
How each payment is split
Interest is the cost of using the lender's money for a period. It is always worked out on the principal still owed during that period:
Interest = balance owed × rate for the period
Whatever is left of the payment after interest repays principal:
Principal = payment − interest
The entry for each payment has the same shape:
- Debit Interest Expense for the interest.
- Debit Notes Payable for the principal.
- Credit Cash for the full payment.
Because the balance falls with every payment, interest falls too. On a note with equal payments, the interest part shrinks over time and the principal part grows. Early payments are mostly interest; late payments are mostly principal.
Two payment patterns are common. With equal total payments, every payment is the same amount and the split changes each time. With equal principal payments, the business repays the same amount of principal each time plus interest on the balance, so the total payment shrinks.
Worked example 1: the first annual payment
Juniper Landscaping borrowed $100,000.00 from Cedar Credit Union on a 6-year installment note at 7% annual interest. It repays the note with equal payments of $20,979.58 at the end of each year, and each payment covers that year's interest first.
On the first payment, the balance owed is the full amount borrowed:
Interest = $100,000.00 × 7% = $7,000.00
Principal = $20,979.58 − $7,000.00 = $13,979.58
| Account | Debit | Credit |
|---|---|---|
| Interest Expense | $7,000.00 | |
| Notes Payable | $13,979.58 | |
| Cash | $20,979.58 |
After this payment, the balance owed is $100,000.00 − $13,979.58 = $86,020.42. The second year's interest is worked out on that lower balance, so it will be less than $7,000.00, and more of the second payment will go to principal.
The first few rows of the schedule
Laying the payments out as a schedule makes the pattern easy to see. These figures are my calculation from the note above, rounded to the cent:
| Year | Opening balance | Interest (7%) | Principal | Closing balance |
|---|---|---|---|---|
| 1 | $100,000.00 | $7,000.00 | $13,979.58 | $86,020.42 |
| 2 | $86,020.42 | $6,021.43 | $14,958.15 | $71,062.27 |
Building the whole schedule is a spreadsheet job; the loan amortization schedule in Excel page shows how. The journal entry for any single payment only needs the balance at the start of that period.
Worked example 2: a monthly payment
Pine Street Dental financed new equipment with a $10,000.00 installment note at 6% annual interest, repaid in 24 equal monthly payments of $443.21. Interest is charged monthly on the balance owed.
The rate is quoted per year, but the period is a month, so use one-twelfth of the annual rate:
Interest = $10,000.00 × 6% ÷ 12 = $50.00
Principal = $443.21 − $50.00 = $393.21
| Account | Debit | Credit |
|---|---|---|
| Interest Expense | $50.00 | |
| Notes Payable | $393.21 | |
| Cash | $443.21 |
Worked example 3: a later payment
Juniper Landscaping borrowed $89,000.00 on a 6-year installment note at 7% annual interest, repaid with equal payments of $18,671.83 at the end of each year. After the payments made so far, $63,245.41 of principal is still owed. Record the third annual payment.
Interest is charged on what is still owed, not on the amount first borrowed:
Interest = $63,245.41 × 7% = $4,427.18
Principal = $18,671.83 − $4,427.18 = $14,244.65
| Account | Debit | Credit |
|---|---|---|
| Interest Expense | $4,427.18 | |
| Notes Payable | $14,244.65 | |
| Cash | $18,671.83 |
Worked example 4: equal principal payments
Harbor Bakery borrowed $87,000.00 on a 3-year note at 8% annual interest. At the end of each year it repays $29,000.00 of principal plus that year's interest on the balance owed during the year. Record the second annual payment.
During the second year, one principal payment has already been made, so the balance owed is:
$87,000.00 − $29,000.00 = $58,000.00
Interest = $58,000.00 × 8% = $4,640.00
Payment = $29,000.00 + $4,640.00 = $33,640.00
| Account | Debit | Credit |
|---|---|---|
| Interest Expense | $4,640.00 | |
| Notes Payable | $29,000.00 | |
| Cash | $33,640.00 |
Here the principal is fixed and the total payment is worked out. With equal total payments it is the other way round: the payment is fixed and the principal is worked out. In both cases interest comes from the balance owed.
Common mistakes and how to avoid them
Each mistake below is one that our exercises catch and explain.
Putting the whole payment against the note
It is easy to see a payment to the lender and debit Notes Payable for all of it. But part of every payment is interest, which is an expense, not a repayment of debt. In the first Juniper example, debiting $20,979.58 to Notes Payable would understate expenses by $7,000.00 and make the liability fall too fast. Work out interest first, then debit Notes Payable for the rest.
Treating the whole payment as interest
The opposite slip is to record the entire $20,979.58 as Interest Expense. That overstates expenses and leaves Notes Payable at the full $100,000.00 even though the business has started to repay it. Each payment also repays principal.
Using a full year's rate for a monthly payment
A 6% annual rate does not mean 6% a month. In the Pine Street example, $10,000.00 × 6% = $600.00, which is more than the whole $443.21 payment, so the entry would show no principal repaid at all. For a monthly payment, use the annual rate ÷ 12. The same idea applies to quarterly payments (÷ 4) and six-monthly payments (÷ 2).
Charging interest on the original loan
After a few payments, the business owes much less than it first borrowed. In the later Juniper example, $89,000.00 × 7% = $6,230.00 overstates interest by $1,802.82 and understates principal by the same amount. In the Harbor Bakery example, $87,000.00 × 8% = $6,960.00 instead of $4,640.00. Always use the principal still owed during the period.
Leaving the interest out of an equal-principal payment
With equal principal payments, the fixed amount is only the principal. Recording a $29,000.00 payment for Harbor Bakery's second year forgets the $4,640.00 of interest that is paid along with it. The cash paid, and the credit to Cash, is $33,640.00.
Current and long-term portions
On the balance sheet, Notes Payable is split in two. The principal due within the next year is a current liability, because it will be paid soon. The rest is a long-term liability. Using the first Juniper schedule, at the end of year 1 the business owes $86,020.42, of which $14,958.15 is the principal in the next payment. That amount is shown as current, and the remaining $71,062.27 as long-term.
The split is a presentation step; it does not need a journal entry in the exercises on this page. It is worth knowing because it explains why a lender or a manager often asks how much of a loan is due this year.
When a payment date and a year end do not match
The examples here all have payments that fall at the end of a period. When a payment falls after the year end, the interest that has built up since the last payment must still be recorded in the year it was incurred. That is done with an adjusting entry that debits Interest Expense and credits Interest Payable. The accrued expenses adjusting entry page explains how.
A quick routine for any installment payment
- Find the principal still owed at the start of the period. On the first payment, that is the amount borrowed.
- Find the rate for the period: the annual rate for annual payments, the annual rate ÷ 12 for monthly payments.
- Interest = balance × period rate, rounded to the cent.
- With equal total payments, principal = payment − interest. With equal principal payments, payment = principal + interest.
- Debit Interest Expense and Notes Payable, credit Cash, and check that the entry balances.
- Reduce the balance by the principal before working out the next payment.
Frequently asked questions
Why does the interest part of each payment get smaller?
Interest is charged on the balance still owed, and every payment repays some principal. A smaller balance means less interest, so more of each equal payment goes to principal.
Is interest expense the same as the principal repayment?
No. Interest is the cost of borrowing and is an expense on the income statement. The principal repayment reduces a liability on the balance sheet and is not an expense.
Where does the payment amount come from?
The lender sets it when the note is signed, based on the amount borrowed, the rate and the number of payments. In bookkeeping you are usually given it and only have to split it.
What is the difference between a note payable and accounts payable?
Accounts payable are short-term amounts owed to suppliers, usually without interest. A note payable is a formal written promise to repay borrowed money, usually with interest and a set schedule.
How is an installment note different from a bond?
A note is usually owed to one lender and repaid in installments. Bonds are sold to many investors, pay interest regularly and repay the face value at the end. The bonds payable journal entries page covers them.