Joaquin Herrera sells hand made leather bags from a pitch at Whitcombe Street Market. In June his bank paid him a five year loan of $6 000 towards a bigger ...
Question 1 Report
Joaquin Herrera sells hand made leather bags from a pitch at Whitcombe Street Market. In June his bank paid him a five year loan of $6 000 towards a bigger stall, and in the same month his sales came to $3 850. Identify the treatment of the loan in his accounts.
Answer Details
A loan is money Joaquin must repay, so it creates an obligation rather than earning anything. It is not income and never enters the income statement. The correct treatment is as a capital receipt, shown as a liability rather than as income: bank is debited with $6,000 and the loan account is credited, and because the loan runs for five years it appears among non-current liabilities.
Adding it to sales would report $9,850 of income for June when only $3,850 was earned by trading, which overstates profit by the whole loan. The $6,000 is also not added to the cost of the stall: the loan and the purchase of the stall are two separate transactions, and the stall is capitalised only when and if the money is actually spent on it. The interest, when paid, is a revenue expense in the income statement, but that does not change how the loan itself is recorded.
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