How to Report a Line of Credit on a Balance Sheet

A line of credit provides a business with flexible access to capital from a financial institution. It establishes a preset borrowing limit that a company can draw from as needed, repay, and then draw from again. Unlike a term loan, a financial obligation is only created for the amount actively borrowed. This instrument is often used to manage cash flow fluctuations or fund short-term operational needs.

Balance Sheet Classification of a Drawn Line of Credit

When a business draws funds from its line of credit, the outstanding balance is reported as a liability on the balance sheet. The primary consideration for reporting this debt is its classification as either a current or non-current liability. This distinction depends on the repayment timing required by the credit agreement, following U.S. Generally Accepted Accounting Principles (GAAP).

A liability is classified as current if it is due to be settled within one year of the balance sheet date. If the line of credit terms require the outstanding balance to be paid back within 12 months, it must be presented as a current liability. This is common for revolving lines of credit where balances are paid down frequently.

A portion of the drawn amount may be classified as a non-current liability if the business has a formal agreement and the ability to defer settlement for more than 12 months. For example, if the agreement allows the balance to be converted into a multi-year term loan, the debt would be considered non-current. The classification hinges on the contractual rights at the date of the financial statements, not on management’s intent to repay.

Certain features in the credit agreement, such as an acceleration clause, can affect this classification. This clause allows a lender to demand immediate repayment if certain conditions are met. If a covenant violation has occurred by the balance sheet date, the debt is reclassified to current unless the lender provides a waiver before the financial statements are issued.

Journal Entries for Line of Credit Transactions

Activity related to a line of credit is recorded through specific journal entries affecting the balance sheet and income statement. Each transaction, including drawing funds, incurring interest, and making payments, requires a distinct entry.

When a company draws funds, it records an increase in cash and a corresponding increase in liabilities. For instance, if a business draws $50,000, the journal entry is a debit to the Cash account for $50,000 and a credit to a “Line of Credit Payable” account for the same amount. This entry establishes the initial liability on the balance sheet.

Interest on the outstanding balance is the cost of borrowing and is recognized as an expense. If interest is paid immediately, the entry is a debit to “Interest Expense” and a credit to “Cash.” If interest accrues, the entry is a debit to “Interest Expense” and a credit to “Interest Payable” or the “Line of Credit Payable” account.

Making a principal repayment reduces the outstanding liability and cash. A payment debits the “Line of Credit Payable” account and credits the “Cash” account. If a payment covers both principal and interest, the entry is split; for example, a $10,500 payment for $10,000 of principal and $500 of interest would debit “Line of Credit Payable” for $10,000, debit “Interest Expense” for $500, and credit “Cash” for $10,500.

Required Financial Statement Disclosures

Beyond reporting the balance on the balance sheet, U.S. GAAP requires detailed disclosures in the footnotes of the financial statements. These disclosures provide investors and creditors with a comprehensive understanding of the company’s obligations and available liquidity.

The disclosures must specify the total amount of the credit line available and the portion that remains unused at the balance sheet date. The terms of the agreement are also detailed, including the interest rate, how it is determined, and the maturity date of the agreement.

If any company assets are pledged as collateral, the nature and carrying amount of these assets must be described in the footnotes. This information is important for other creditors, as it indicates which assets are encumbered and not available to satisfy other claims.

Finally, the company must disclose any significant covenants associated with the line of credit. Covenants are conditions that the borrower must adhere to, such as maintaining specific financial ratios like a minimum current ratio or a maximum debt-to-equity ratio.