Kindly help to record this Vehicle purchase

Vehicle cost ---- 156,000/-

Down Payment— 39,000/-- cheque date 14/11/2018

Loan Amount ---- 117,000/-

Interest ---------- 17,515/-

Total Amount – 134,515/-

Monthly installment ---- 3,737 x 35 months cheque + last cheque – 3,720 x 1 month cheque starting date ----- 14/12/2018

  1. Create the vehicle as a fixed asset.
  2. Create a liability account for the loan (or choose one you already have).
  3. Record receipt of proceeds of the loan into your bank account, if they come to you that way.
  4. Record purchase of the vehicle with a combination of payment and journal entry, depending on how the loan proceeds are applied. See https://www.manager.io/guides/9106.
  5. Interest has nothing to do with the purchase. It is posted to an expense account as you make monthly payments against the loan. Those payments will be posted partially to the loan liability account and partially to interest.
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We are looking at getting our first business loan (for a company car) so straight off the bat, let me say, thanks for that info!

I just have a question about the last sentence of part 5:

(pardon my ignorance on precise terminology and how to correctly apply this)

Realising that accounting is a grand topic and there are at times multiple ways to do things, my immediate thought was to tackle it a slightly different. What you’ve said about recording part of the payment as loan liability and part as interest would require you to manually split that calculation each payment. I see that as something that could be messy (and for me, prone to error)

Would it be possible to just record the whole payment as going against the loan and making a separate entry for interest on the loan as an expense item once per month (or as often and) in the same way the financial institution would?

The reason I ask is because:

  1. what happens if you make multiple payments in the month? You have to make allowances for “this much principle, this much interest” on each payment? Or would you only do it for the first one?
  2. when I pay my credit card, I just make a payment of $X and elsewhere in the month I record the interest as the bank charges it.

Is it a case you could do it either way or is there a preferred/better way?

We haven’t done it yet, but it’ll more than likely be in the next few days/couple of weeks.

If you post the full payment to the loan then you will be reducing the loan balance by more than you should. Only part of your payment goes towards reducing the loan balance, the rest pays the interest due

I believe this type of transaction is under IFRS 16 and here is a helpful video with a vehicle example: https://www.youtube.com/watch?v=bv9gF69NJrE

Since I don’t have a working example (ie, my approach is totally conceptual in my head at this time), my thought process was:

  • There is the loan liability
  • you make a payment against that liability
  • there is an expense of interest
  • that interest appears as an expense against the loan (entered on the day it appears on my statement)

It should be obvious I’m not an accountant, or savvy in this area, but notwithstanding that, is my approach fundamentally flawed?

So, I went ahead and created an example of this, and yes, I am seeing that I am confused. Here is how I interpreted the loan working, could someone explain to me where my thinking is wrong please. Here si what I have:

we want a $100,000 car

(all figures are arbitrary and used to make the maths easier)


our account balance is obviously down $4000 from the repayments (all other income and expenses are removed for clarity)

a journal entry is created on the last day of the month (or whenever interest is applied):

Summary

According to that screen, I have spent $4000, been charged $2000 in interest (huge, I know, it is just an example/test account), still owe $98,000, and have retained earnings of -$2000 (I’m not sure about that).

To me, that is the clearest way to do it and how my credit card, previous personal car loans and my home loans work. ie, multiple payments a month and one interest charge per month.

Given the interest will be charged daily (in most cases) how do you work out exactly how much interest and how much principle is paid off on each repayment?

TIA

@d3mad, you are making things much too complex. No journal entries are necessary. You enter the payment with two line items. The first is posted to the loan liability account to reduce it. That number will generally increase each month as the principle is reduced and less of the constant payment goes to interest. The second line item is posted to the interest expense account.

Most loan paperwork will include a schedule of payments with amounts for principle and interest for each payment. Or, you can apply standard financial formulae to calculate your own. (Excel includes these.) Sometimes, a monthly notice is sent by the lender with the breakdown. Regardless, the determination of how to split the payment is your responsibility to find or calculate.

But this is precisely the problem area I would like addressed. I don’t want to manually calculate anything, I have a computer and much software for that.

I personally always sign loan contacts that allow extra payments. The interest per month is not fixed and (as can be witnessed in other areas of manager), not everyone rounds the same way (regardless of statutory requirements) and thus will also lead to errors in your records that you will later have to find. Ergh. Ugly.

I only suggested a Journal entry (once periodically) because I don’t yet know of a better way to account for it. At the moment with credit cards I just record it as a payment against an interest expense account (I’m on mobile I’ll have to confirm later)

I’m sure a single line payment based on a statement provided by your final institution is much cleaner than manually calculating it yourself.

In your example, how does a user calculate which values go on what line item? Where did one arrive at these values, and isn’t that process error prone? Some loan documents contain formulae, others contain a written adaptation of a formula and should it really be necessary for users to keep a copy of that on the desk for manual calculations???

Let’s not forget (you could argue) EVERYTHING in manager is your responsibility, so to say “calculating it is up to you” is moot. The whole idea is that you use software that makes your life easier, not leave parts or for you to do yourself. You do seem to keep missing that point.

Could you indicate why you think my guess at how to complete this is making it more difficult? I honestly see it as being easier. I’m not calculating anything. I not making any assumptions. I’m certainly not guessing. I’m simply recording the debits and credits to the account (much like a bank reconciliation).

I did not suggest you should. I told you Excel has functions for this.

Many (probably most) do. But when you make extra payments, all additional amounts (usually) go to principle. And that changes the interest calculations for future payments.

Usually true, even if you do not make additional payments, because you are paying interest on a declining principle balance. (Some loans are structured differently, but not most.)

You will never be able to enter a single line payment, because each payment will be split between principle (the loan liability account) and interest (the expense account). So you always need two lines, no matter how you determine the numbers.

Using standard financial formulas based on principle, interest rate, and number of payments, easily found online or available on some handheld calculators or in a spreadsheet program. The question is how the loan documents define the calculations. Is interest calculated daily? Monthly?

Unfortunately, yes, unless the lender sends monthly statements with breakdowns and all payments as of a certain date are considered to have been applied on another specific date.

Not at all. I readily admit accounting for loans with constant payments is a real pain. While the basic concepts are straightforward, matching your calculations to those of the lender is seldom simple, because so many things in the basic formulae can be interpreted so many ways. The one thing you know for sure is that the lender will interpret everything to their advantage, not yours. Sometimes, you have to make the payment with your two line items, then go online to the lender’s web site to look up your actual balance and back out the numbers after the fact to edit the transaction. (You’ll only be editing the apportionment between principle and interest, not the total.)

Sure. Your method requires two entries: the payment and a journal entry that can only be entered after you somehow determine the interest amount. It’s easier to record one payment with two lines. The process of determining the exact interest versus principle will be the same. It will depend on the terms of the loan and the resources available from the lender. Your method implied that interest might be posted on a different day from the principle, but that does not happen. They are posted simultaneously by the lender. So why not combine the transaction?

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I admit I am using my home loan as an example. So it may be different.

I make a minimum of two payments a month. Often 3. They are above the minimum. Interest is calculated daily. Interest is added to my account most often not on the same day as I make payment.

I personally do not think it would be possible to break down interest vs principle in that case because you would specifically require a spreadsheet to calculate it. (Extra steps, error prone)

Why calculate it when they provide you the exact figure?