Let's look at the repayment of debts overtime and how we calculate interest on it So here we have a four year 100 million loan with straight line repayments and an interest rate of 5% on beginning balance So how's that debt going to go down overtime? Well we'll start with 100 and if it's over 4 years we'll repay 25 each period So here we have that, beginning 100, repaid 25 and that goes down to 75 Year 2 start with 75, down by 25 to 50 and then in year 3 it goes down to 25 and year 4 down to zero We've been told that interest is calculated in this example on beginning balance It could be calculated in a different way, it could calculated on average balance or monthly balance. It doesn't matter. So the interest expense here at the end of year 1 is going to be 5% times by the 100 (the beginning balance) that's 5. In year 2 it's going to be 5% of the beginning balance 75, so that gives us a rounded 3.8 Year 3, 5% of the 50 (that's 2.5) and year 4, 5% of the 25 (that's a rounded of 1.3) Great! So we've seen how the debt is gradually paid off and how the interest is calculated How will we account for this? Well the initial issuance of the loan will see our cash go up, fantastic! We've received a load of cash from the bank What's the other half of our balance sheet formula? Assets = Liabilities + Equity We've got cash going up, the other half will see our liabilities go up. Debt goes up by 100 and the balance sheet balances How do we account for repayment of a loan? Well if we repay 25 (that's cash down 25), we have to spend that cash so assets have gone down But I now owe less money (I have a lower obligation), so debt goes down 25, your liabilities go down Assets go down 25, liabilities go down 25, the formula still balances Lastly what about the interest expense? In year one that was 5 Well cash goes down 5, we've spent cash, we've had to give it to the bank (fair enough). What's the other half? Well interest expense is an income statement item, my income statement expense has just gone up That means my income statement profit has gone down which flows through to the balance sheet retained earnings (my retained earnings goes down as well) So cash as an asset goes down 5 and equities retained earnings goes down 5 as well and the balance sheet formula still balances Okay, so that was showing us how it was all calculated and how the accounting worked. Now let's see the balance sheet presentation Here we've got the same debt schedule from the previous page It's the ending debt that I'm going to focus on here Have a look, in year 1 the ending debt is 75 How will that be presented in the balance sheet? Well some of it is going to be in current portion of long term debt and some of it is just in long term debt Why is it split up? Well if we know that 25 of it is going to be repaid in year 2 i.e. within the next 12 months from the end of year 1 Then that is a current liability, so as a current liability it goes into the current portion of long term debt within current liabilities The remaining 50 will be repaid over 12 months time. It will be repaid in year 3 and year 4, so that's a long term debt So the 75 of debt in year 1 is split 25 and 50 Fast forward to year 2, I've now got 25 as current portion of long term debt That 25 will be repaid off in year 3. The other 25 is long term debt, it will be repaid off after year 3 Now in year 3 the ending debt is 25, that's all in the current portion of long term debt And in year 4 we finish with no debt So current portion of long term zero and long term debt zero