A line of credit (LOC) is a flexible loan allows a company to borrow up to a specified amount as needed. When a company draws on a line of credit, it records a liability to the lender and increase in cash. When company repays the amount, it reduces the liability and cash.
Example 1: Drawing on a Line of Credit
Scenario:
Company A draws $50,000 from its line of credit on September 1, 2024.
Journal Entry:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 09-01-2024 | Cash A/c Debit | 50,000 | |
| 09-01-2024 | To Line of Credit Payable A/c | 50,000 |
Explanation:
- Cash will debited to record the cash inflow from the line of credit.
- Line of Credit Payable will credited to recognize the liability for the amount borrowed.
Example 2: Repaying the Line of Credit
Scenario:
Company A repays $20,000 amount borrowed on October 1, 2024, including $500 in interest.
Journal Entry:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 10-01-2024 | Line of Credit Payable A/c Debit | 20,000 | |
| 10-01-2024 | Interest Expense A/c Debit | 500 | |
| 10-01-2024 | To Cash A/c | 20,500 |
Explanation:
- Line of Credit Payable will debited to reduce the liability for the amount repaid.
- Interest Expense will debited to record the cost of borrowing.
- Cash will credited to reflect the cash outflow for both the principal repayment and interest payment.
Example 3: Adjusting for Interest Accrual (if interest is not paid immediately)
Scenario:
At the end of the month, Company A accrues $200 of interest on the outstanding line of credit.
Journal Entry:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 09-30-2024 | Interest Expense A/c Debit | 200 | |
| 09-30-2024 | To Accrued Interest Payable A/c | 200 |
Explanation:
- Interest Expense will debited to recognize the cost of borrowing for the month.
- Accrued Interest Payable will credited to record the liability for the interest not yet been paid.
These entries help track the use, repayment, and interest expenses related to a line of credit, ensuring accurate financial reporting.