Borrow (Accounting)

To borrow is to receive money, or occasionally another asset, in exchange for a promise to repay it at a later date, usually with interest. In accounting, borrowing creates a liability for the borrower and a receivable for the lender. The borrowed amount is called the principal, and the cost of using it is interest, which is recognized as an expense over the time the money is outstanding.

Businesses borrow through bank loans, lines of credit, notes, bonds and leases, among other forms. Whatever the form, the accounting follows the same pattern: the cash received is recorded together with a liability, interest is accrued as time passes, and repayments reduce the liability. Borrowing is a financing activity, not revenue, so it never increases income, even though it increases cash.

If you borrow $1,000 from a friend, you have $1,000 more in your pocket, but you are not $1,000 richer, because you owe it back. Accounting shows both halves: more cash, and a matching debt.

The friend may ask for a little extra when you repay, say $50 after a year. That extra is the price of borrowing. It builds up gradually, so if you close your books halfway through the year, you already owe about $25 of it, even though you have not paid anything yet.

On October 1, a company borrows $120,000 from a bank on a one-year note payable at 6% annual interest, with principal and interest due at maturity. The entry is a debit to Cash $120,000 and a credit to Notes Payable $120,000.

At its December 31 year end, three months of interest has built up: $120,000 × 6% × 3/12 = $1,800. The adjusting entry debits Interest Expense $1,800 and credits Interest Payable $1,800. On September 30 of the following year the company repays $127,200: it debits Notes Payable $120,000, Interest Payable $1,800 and Interest Expense $5,400 for the nine months of the new year, and credits Cash $127,200.

• Term loans, repaid over a fixed schedule set out in a loan amortization schedule.
• Revolving facilities and a line of credit, which allow repeated borrowing and repayment up to a limit.
• Notes, including a promissory note given to a supplier or lender.
• Bonds issued to many investors, recorded as bonds payable and often sold at a premium or discount.
• Mortgages secured on real estate.

Borrowings due within one year, or the operating cycle if longer, are current liabilities. Longer borrowings are long-term liabilities, except that the principal due in the next year is shown as the current portion of long-term debt. On the statement of cash flows, the cash received from borrowing and principal repaid are financing activities, while interest paid is classified as operating under US GAAP.

The notes to the financial statements describe each significant borrowing: interest rates, maturity dates, collateral, covenants and the amounts due in each of the next five years. A breach of covenant that gives the lender the right to demand immediate repayment can force long-term debt to be reclassified as current unless a waiver is obtained, which can dramatically change a company's apparent liquidity. Costs paid to arrange a loan are deducted from the carrying amount of the debt and amortized over its term as part of interest expense.

Companies borrow to fund growth, buy equipment, cover seasonal swings in working capital or refinance older debt. Because interest is generally tax-deductible for businesses, subject to limits, debt can be cheaper than equity. Borrowing also creates leverage: if the business earns a return above the interest rate, owners gain, but if it earns less, losses are magnified and the risk of default rises. Lenders assess this risk using measures such as the debt-to-equity ratio and interest coverage, and the terms they offer reflect how much the borrower has already borrowed.