Hopefully you understand debits and credits. If you're incurring interest expense and NOT paying it, yes, it increases the loan balance. That's the credit side of the entry. Since you haven't paid it and since you're a cash basis tax payer and can't deduct it, the debit would fall to the balance sheet. Seems weird, right?
Think of it like this: you owe the bank $10k in interest; however, they say "Keep it for now, you'll owe it to us.” So they increase what you owe by $10k. It’s almost like they "gave" you another $10k, but you didn't receive it in cash. So if you want to show what you really owe the bank you have to increase the loan by $10k, which increases the liability; however, for your "balance" sheet to balance, you have to increase assets by $10k. Since you didn't receive it in cash, you have to add another asset called deferred interest.
Don't make me explain that again.....
Thanks Tim, that actually did help a lot. And explaining accounting principles to me is no easy feat!
This first appeared on Dentaltown.