Accrued Interest Meaning
Accrued Interest is the interest on the principal of the loan or the coupon on a bond that has been accrued but not yet paid. This is accounted in the books as account payables if the Company owes to the bond investors or creditors but is still not transacted and paid.
Accrued interest expense is recorded as a part of the accrual principle of accounting. As per the accrual principle of accounting, expenses are to be considered when they are incurred and not when they are actually paid. Hence, the interest which is to be paid on a future date but is accumulated till now is recorded as an expense and a liability by the Company.
Let us consider an example of accrued interest calculation in a bond to understand this concept:
A bond investor holds a bond of a Company XYZ Inc. which is worth $ 100 and pays coupon semi-annually at an interest rate of 12%. The last coupon was made 2 months back and he wants to sell the bond to the new investor.
The new investor will pay him $ 100 and last two months accrued interest expense is calculated as per below.
= 12%/12 * 2 * 100 = $ 2
Thus, the new investor will pay = 100 + 2 = $ 102 for the bond
Accrued Interest Formula
This interest is calculated using the following accrued interest expense formula:
Time fraction is the ratio of number of days in the period for which interest is accrued to the number of days in the year
Accrued Interest Calculation Example
Let us consider the following example:
Consider a Company has taken a loan for $ 10,000 which an interest rate of 15% P.A. and the payment is done monthly. The last payment was done on 20th March whereas the balance sheet is to be prepared on 31st March. Calculate the accrued interest expense to be reported on the balance sheet?
Since the balance sheet is to be made on 31st March and last payment was done on 20th March, the number of days in the period is 11.
Now, the fraction of days = 11/365
Thus, Accrued Interest Formula = Principal * Rate of Interest * Time fraction
Accounting for Accrued Interest Expense
While accounting for accrued int two sets of accounts are adjusted – the interest expenses account on the profit and loss statement and the accounts payable on the balance sheet.
The interest expense on profit and loss statement is increased by the amount of the interest that is yet to paid by the Company. This is because of the accrual principle of accounting and the Company has to record any interest accrued but yet to pay.
source: Colgate SEC Filings
The accounts payable on the liabilities side of the balance sheet is added with the interest payable as it the expense which is yet to be paid by the Company.
source: Bloom Energy SEC filings
The above entered will be done by the borrower on its profit and loss statement and the balance sheet. The lender will report the interest as revenue on its PnL statement and a current asset as accounts receivables on the balance sheet.
This interest is an amount that has been accrued but not yet paid over the time period due to debt owned or owned by the Company. The interest is accrued from the last payment date till the date of preparation of the accounts if it is not paid and the due date is on a later date. Such an amount is recorded as interest in receivables of payables as the case maybe i.e. if the Company has taken a loan it will record interest payable and if has given a loan say, to another business it will record an interest receivable.
This has been a guide to Accrued Interest Expense. Here we discuss its meaning, how to calculate accrued interest along with its formula, examples, and accounting. You may also have a look at these articles below to learn more about Accounting basics –