When the company signs an agreement with the bank for the overdraft, it is considered as taking a loan. However, unlike the loan, after signing the bank overdraft agreement, the company usually does not need to make any journal entry until it starts using the overdraft by withdrawing the money from the overdraft (e.g. to use in the business operation).
This is due to the bank overdraft is considered an off-balance sheet item after the company signs an agreement with the bank. Hence, unless the company is in the special sector, such as the banking sector where companies in it are usually required to also record off-balance sheet items, the journal entry for bank overdraft only starts when the company uses the overdraft (e.g. by withdrawing the money from the bank overdraft).
Of course, if the bank overdraft has the monthly fee attached (e.g. minimum fee), the company needs to account for it as it occurs. Otherwise, the company will just treat it the same as the other types of loan when it uses the money in overdraft and starts to record the accrued interest at period end adjusting entry.
Bank overdraft journal entry
At the agreement date
There is no journal entry required at the date of signing the agreement of the overdraft with the bank. This is due to the bank overdraft agreement is considered as an off-balance sheet item. It goes to the balance sheet only when the company starts using it.
At the date of using bank overdraft
When the company starts using the bank overdraft (e.g. taking money from the overdraft loan), it can make the journal entry by debiting the cash account and crediting the overdraft loan account.
At the period-end adjusting entry
After using the bank overdraft, the company needs to account for the interest expense and interest payable on overdraft at the period end adjusting entry.
|Interest payable – overdraft||$$$|
At the payment date of bank overdraft
The company can make the journal entry when it makes the payment of overdraft to the bank including interest as below:
|Interest payable – overdraft||$$$|
This journal entry is made to eliminate both the overdraft loan and interest payable that the company has recorded in the prior period.
Bank overdraft example
For example, on June 1, 2020, the company ABC signs an agreement with the bank for an overdraft of $15,000. The overdraft loan period is 6 months (from June 1 to December 1, 2020) with an interest of 12% per year on the used amount.
The company ABC is required to pay back any amount of overdraft used with the interest at the end of the overdraft loan period.
On July 1, 2020, the company ABC withdraws $10,000 of the bank overdraft to use in the business operation. After that, it has not used any more amount of overdrafts and there is no interest or fee on the unused balance.
What is the bank overdraft journal entry on?
- on June 1, 2020, when the company signs an agreement with the bank for overdraft
- on July 1, 2020, when the company uses $10,000 of bank overdraft balance
- on July 31, 2020, when the company makes the July 31 adjusting entry
- on December 1, 2020, when the company paybacks the used amount with the interest at the end of the overdraft loan period.
On June 1, 2020
There is no journal entry required for the bank overdraft on the date that the company signs an agreement with the bank. This is due to it is still an off-balance sheet item if the company has not withdrawn the money from the bank overdraft loan yet; even though the bank agrees that the company can withdraw money anytime during the loan period.
On July 1, 2020
When the company withdraws $10,000 from the overdraft to use, it needs to make the journal entry for the bank overdraft as below:
On July 31, 2020
The company needs to account for the $100 (10,000 x 12%/12) of the accrued interest on the used balance of bank overdraft at the July 31 adjusting entry as below:
|Interest payable – overdraft||100|
On December 1, 2020
At the end of the overdraft loan period, when the company makes the payment back to the bank, both the used balance of overdraft and the interest, it can make the journal entry as below:
|Interest payable – overdraft||500|
The $500 of interest payable – overdraft comes from the accrued interest for 5 months after the company has used the $10,000 on July 1, 2020. As the payment date is on December 1, 2020, it is safe to assume that the company has made the adjusting entry for the $100 interest at the end of each month for 5 months.
It is useful to note that the bank overdraft usually comes with a minimum fee in case the company has not used the overdraft at all during the loan period. This is so that the bank will not make a loss if the company does not use the overdraft at all after signing the agreement.