8

I'm trying my hand at double-entry bookkeeping for my personal finances. While I get the gist, I have trouble with the details. Please bear with me if I use the wrong terminology.

I have lent some money to a family member. How should I book this?

I could debit the Liabilities: Loans account and credit my bank account. But then my loans account can get a negative balance, right? Or should I create a new account under Income or Assets for that?

5

When you borrow money - you create a liability to yourself (you credit your Liabilities:Loans account and debit your Asset:Bank account).

When you lend money - you create an asset to yourself (you debit your Asset:Loan account and credit your Asset:Bank account).

6

When trying to understand accounting, it's always helpful to reference the balance sheet identity, thus

Assets = Liabilities (+ Equity)

, and debits and credits must balance.

In this case, one would

Dr                              Cr
$X Loans to family members      $X Cash

So that "Cash" is subtracted (credited) from assets, and "Loans to family members" is added (debited) to assets.

The income identity is treated differently as

Revenues - Expenses = Income

So, unless if the "Cash" and "Loans to family members" did not start imbalanced, there was no revenue or expense. A revenue will be any interest paid. The expenses will be any costs related to loaning the money such as drafting a contract or any amount defaulted.

Assets are not liabilities

A liability on the balance sheet is a liability owed by the entity measured, such as a person or a company.

The family members in this case are the borrowers, so they are the ones who must increase their liability accounts like so:

Dr          Cr
$X Cash     $ Loans owed by family members

The lender to family members would not increase liabilities in this case because the lender is not borrowing from the borrower.

Debits, credits, and the balance sheet

Debits & credits must be equal, or an identity is violated.

Debits add to assets and subtract from liabilities (and equity) while credits subtract from assets and add to liabilities (and equity).

If a lender were to try to simultaneously subtract cash from assets and add loans to liabilities to book a loan, the operation would look like this

Dr    Cr
?     $X Cash
?     $X Loans to family members

This would cause an immediate imbalance because there are no offsetting debits, but more importantly, crediting Loans to family members as a liability would actually mean that the lender owes Loans to family members.

  • You may consider OID as income and increase the loan balance, depending on how you want to account for that... – littleadv Jan 9 '14 at 5:07
  • But why shouldn't I subtract (credit) "Cash" from assets and subtract (debit) "Loans to family members" from liabilities? It would still keep the balance sheet identity intact. Say I start with $100 assets, $50 liabilities and $50 equity (A $100 = L $50 + E $50). Then lending $10 to a family member could leave me with A $90 = L $40 + E $50, which is still balanced. How do I know which way is the correct way, for similar situations in the future? – Daniel A.A. Pelsmaeker Jan 10 '14 at 2:28
  • Because lending money does not reduce any of your own liabilities or create any new one for that matter. Lending money means money (decrease in assets) is transformed into a right to collect future payments (increase in assets). – ApplePie Feb 24 '17 at 0:54

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