When loan costs are significant, they must be amortized because of the matching principle. In other words, all of the costs of a loan must be matched to the accounting periods when the loan is outstanding.

To clarify this, let’s assume that a company incurs legal, accounting, and registration fees of $120,000 during February in order to obtain a $4 million loan at an annual interest rate of 9%. The loan will begin on March 1 and the entire $4 million of principal will be due five years later. The company’s cost of the borrowed money will be $360,000 ($4 million X 9%) of interest each year for five years plus the one-time loan costs of $120,000.

It would be misleading to report the entire $120,000 of loan costs as an expense of one month. Hence, the matching principle requires that each month during the life of the loan the company should report $2,000 ($120,000 divided by 60 months) of expense for the loan costs in addition to the interest expense of $30,000 per month ($4 million X 9% per year = $360,000 per year divided by 12 months per year). The combination of the amortization of the loan cost plus the interest expense will mean a total monthly expense of $32,000 for 60 months beginning on March 1.

Learn more about Accounting Principles.

About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the creator of the AccountingCoach Pro which has been praised for its ability to simplify accounting in a way that anybody can understand.

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