How to record a loan refinancing in QuickBooks

A gal named Peggy asked me this question:

The business has undergone a loan refinancing. I need to close out the old loan and open a new one with the new balance and new account number. Can you help? Thanks.

My answer:

There might be other ways, but here’s how I would do it.

First, when dealing with a loan refinancing, it is important to reconcile the old loan. Please do not neglect this step. We will transfer the reconciled balance from the old loan to the new one. If you need help reconciling, see my book on Amazon, Get More from QuickBooks: Reconciling Tips, Tricks, and Traps (to Avoid) in QuickBooks.

After reconciling the old loan, make a note of the ending balance.

Second, go to the Chart of Accounts and set up a new Long Term Liability account. Name it something that looks like this:

Bank of America 9876

“Bank of America” represents the name of the financial institution that holds the loan, and “9876” represents the last four digits of the loan account number.

Third, go to the Transfer Funds screen:

Banking > Transfer Funds

Enter the date of the new loan. In the “Transfer funds from” box, select the NEW loan account. In the “Transfer funds to” box, enter the OLD loan account. I realize that this seems backwards, but I will explain it below. In the Amount box, enter the ending (reconciled) balance of the old loan account. In the memo line, type something like this:

“Closes old loan, and opens new loan 9876” or something similar. Save the transaction.

Fourth, go back to the Chart of Accounts. The old loan should have a zero balance, and the new loan should have the correct starting balance. Make the old loan account inactive by right clicking, and selecting Make Account Inactive. Now hide it by making the appropriate selection in the Chart of Accounts.

The reason the Transfer accounts are switched when recording a loan refinancing:

It’s because of the terminology of QuickBooks. The Transfer Funds From box creates a credit for the selected account, and the Transfer Funds To box creates a debit for the selected account. This window is designed for transferring cash funds, but we are not transferring cash (with a debit balance), we are transferring debt (with a credit balance). Thus, we must credit the new loan account to raise it’s balance, and debit the old loan account to lower it. Many accountants might recommend the General Journal, which is fine of course. I like to use the Transfer Funds window when the transaction involves only Balance Sheet accounts, and when there is only one entry for the debit and one entry for the credit.

Let me know if these loan refinancing instructions were helpful or not. Thanks.

Peggy replied:

Your advice and instructions worked perfectly. This took all of 2 minutes to do, thank you. However, it led to more questions.

I followed your instructions and understood them, but found that the old loans were originally entered as Expenses, so I couldn’t “transfer funds.” It appears the loans have to be entered as “Long Term Liabilities” when you use the Transfer Funds screen.

I came to this conclusion because the drop-down list in the Transfer Funds screen doesn’t include Expenses. I tried to change the old loans so they would be long term liabilities and it wouldn’t let me do that. So, these loans must have been set up incorrectly to begin with.

My answer:

Your answer tells me that my instincts were correct when I asked you to use the Transfer Funds window. Had I instructed you to use the General Journal, the problem you now describe might not have been as clearly revealed because Expense accounts are visible in the General Journal. That you couldn’t see them is what revealed this problem.

You are correct that the Transfer Funds screen does not include Expense accounts. The Transfer Funds screen is truly for “transferring funds,” (or debt); it’s not for making adjustments of other kinds.

Here is the new problem, and unfortunately it is complex: only a portion of a loan payment is an expense, the interest portion. The portion that pays down the principle of the loan is NOT an expense. It reduces the loan balance.

The profit for this company is likely understated. The entire loan payment is being posted to the expense account, instead of only the interest portion of the loan payment. I suggest getting professional, paid, help to rectify this problem. It’s creating inaccurate financial statements, which is probably leading to incorrect tax returns. Thanks again for the feedback.

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