Q: When the balance sheet shows a reduction in Loan to Shareholder when compared to the prior period, i.e., 9/30/2021 vs. 12/31/2020, what is the accounting entry to record the amount by which the note is reduced?
A: If the shareholder repaid the loan by writing a check, the company would debit the Cash account by, say, $5,000, and credit the Loans to Shareholder account by $5,000. As a result, the balance in the Cash account increases by $5,000 and the balance in the Loan to Shareholders account decreases by $5,000.
However, if the company reclassifies the loan to shareholder as a distribution, it would debit Distributions by $5,000 and credit Loans to Shareholders by $5,000. As a result, the increase in distributions decreases retained earnings by $5,000 since it is a contra account to retained earnings.
The balance in the loans to shareholders account decreases by $5,000 as does Total Assets. Because of the $5,000 decrease in retained earnings, Total Net Worth and Liabilities also decrease by $5,000.
Course overview: Borrower Performance, Loan Classification, and the Risk Grid