How to record a
loan refinancing
in QuickBooks

Peggy asks:

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.

Jennifer replies:

I'll assume that you mean to ask about the specific bookkeeping entries in QuickBooks. There might be other ways, but here's how I would do it.

When dealing with a loan refinancing, it is important that the old loan has been reconciled. Please do not neglect this step! We will transfer the reconciled balance from the old loan to the new one. I won't go into detail about reconciling here. If you need more help, here's a url where I wrote some reconciliation instructions:

http://www.jenniferthieme.com/reconcile-statements.html

After the old loan has been reconciled, use a piece of scrap paper to make a note of the ending balance. 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. Once this is set up, 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 (yes, you read that correctly!). In the "Transfer funds to" box, enter the OLD loan account (Yes, you read that correctly too*). 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.

*Why are the Transfer accounts 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. We are not transfering funds, ie, cash, we are transferring debt. Debits and credits to cash are not the same as debits and credits to debt. Debits and credits to cash raise and lower those balances respectively. Debits and credits to debt lower and raise those balances respectively. Thus, we must credit the new loan account to raise it's balance, and debit the old loan account to lower it (to zero, in this case). 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. Many accountants might recommend the General Journal. There really isn't a "right or wrong" window to make this entry, as long as it is made correctly and with the correct notations in the memo lines.

If you would like more details about how debits and credits work, here is a nine minute video I found that explains them really well: 

https://www.youtube.com/watch?v=ahMQng5yfus

Now 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. You can then hide it by making the appropriate selection in the Chart of Accounts.

If you could let me know if these loan refinancing instructions were helpful or not I'd appreciate it. Thanks.

Peggy replies:

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. 

Jennifer replies:

Your answer tells me that my instincts were correct in asking you to use the Transfer Funds screen. Had I instructed you to use the General Journal, the problem you now describe might not have been as clearly revealed. 

You are correct that the Transfer Funds screen does not include Expense accounts. It doesn't include ANY account on the Profit & Loss statement, only accounts on the Balance Sheet. 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. That portion should have been applied to the loan balance, which should have been setup on the Balance Sheet.

It sounds like the profit for this company is being understated. This is because 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.

I'm happy to help with this problem (here is my contact information), but it is too complex for me to fix in this format. Talk to whomever is responsible for the accuracy of the financial statements and tax returns. See if that person is willing do what is needed to fix the problem. Whether it's me or somebody else, it's a problem that needs to be fixed by a professional who is looking at the actual QuickBooks file, and also the tax returns.

Thanks again for the feedback.

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