What is Accrued Interest in Accounting?
In accounting, Accrued Interest is the interest on the loan that has been earned but not yet paid. It is accounted in the books as account payables if the company owes to the bond investors or creditors but is still not paid for. However, for the lenders, this amount will be referred to as accrued interest revenue
Understanding Accrued Interest
Company records as a part of the accrual principle of accountingAccrual Principle Of AccountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. read more. 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 in a bond to understand this concept:
A bond investor holds a bond of a Company XYZ Inc., which is worth $ 100 and pays coupons 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 the last two months accrued interest expenseInterest ExpenseInterest expense is the amount of interest payable on any borrowings, such as loans, bonds, or other lines of credit, and the costs associated with it are shown on the income statement as interest expense.read more is calculated as per below.
= 12%/12 * 2 * 100 = $ 2
Thus, the new investor will pay = 100 + 2 = $ 102 for the bond.
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For eg:
Source: Accrued Interest in Accounting (wallstreetmojo.com)
Accounting for Accrued Interest Expense
While accounting for accrued into two sets of accounts is adjusted – the interest expenses account on the profit and loss statement and the accounts payable on the balance sheet.Accounts Payable On The Balance Sheet.Accounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read more
The interest expense on profit and loss statement is increased by the amount of the interest that is yet to paid by the Company. It 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 sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more is added with 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 sheetAccounts Receivables On The Balance SheetAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. read more.
Conclusion
Accrued Interest is an amount that has been accrued but not yet paid over a period due to debt undertaken or given. 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 or payables as the case may be. i.e., if the company has taken a loan, it will record interest payable, and if given a loan say, to another business, it will record an interest receivable.
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This has been a guide to Accrued Interest in Accounting. Here we discuss its meaning and how to account for accrued interest expense along with practical examples. You may also have a look at these articles below to learn more about Accounting basics –
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