Purchasing equipment with loan is a common accounting transaction in businesses such as construction, manufacturing, and contracting. This article explains accounting treatment, balance sheet impact, and journal entries in a simple and easy-to-understand manner.
What Is Purchase of Equipment with Loan?
When a business buys equipment using a loan:
- The equipment is recorded as a fixed asset
- The loan is recorded as a long-term liability
- Any down payment reduces cash or bank balance
At the time of purchase, only the balance sheet is affected.
Example: Purchase of Equipment Using Loan
A business purchases equipment costing $80,000.
- Cash down payment: $15,000
- Loan taken from bank: $65,000
Accounting Treatment (Balance Sheet Impact)
| Account | Increase / Decrease | Amount ($) |
|---|---|---|
| Equipment | Increase | 80,000 |
| Cash / Bank | Decrease | 15,000 |
| Bank Loan (Long-Term Liability) | Increase | 65,000 |
Journal Entry for Purchase of Equipment
Equipment A/c Dr. 80,000
To Cash / Bank A/c 15,000
To Bank Loan A/c 65,000
(Being equipment purchased with cash down payment and balance financed through bank loan)
Loan Repayment with Interest Accounting Treatment
Loan installment payments usually consist of:
- Principal amount – reduces loan liability
- Interest amount – recorded as an expense
Example: Loan Installment Payment
The business pays the first installment of $2,500, which includes:
- Principal repayment: $1,800
- Interest expense: $700
Accounting Impact of Loan Payment
Balance Sheet Effect
- Cash decreases by $2,500
- Loan liability decreases by $1,800
Income Statement Effect
- Interest expense of $700 is recorded
- Net profit decreases by $700
Journal Entry for Loan Installment Payment
Bank Loan A/c Dr. 1,800
Interest Expense A/c Dr. 700
To Cash / Bank A/c 2,500
(Being loan installment paid including principal and interest)
Important Accounting Points
- Equipment purchased with a loan is a fixed asset
- The loan taken is a long-term liability
- A down payment reduces cash
- Principal repayment reduces loan balance
- Interest is an expense and reduces profit
- Principal repayment does not affect profit
Frequently Asked Questions (FAQ)
Does purchasing equipment with a loan affect profit?
No. Profit is affected only by interest expense and depreciation, not by the purchase itself.
Is interest on loan capitalized?
Interest is generally treated as an expense, unless capitalized during asset construction as per accounting standards.
Conclusion
Correct accounting for equipment purchased with loan helps businesses maintain accurate financial statements. By properly recording assets, liabilities, and interest expenses, companies must ensure compliance and better financial control.