Interest Expense

What is Interest Expense?

Interest expense represents an amount of interest payable on any borrowings which includes loans, bonds or other lines of credit and its associated costs are shown on the income statement. These expenses highlight interest accrued during the period and not the interest amount paid over the time period.

Formula

Interest expense is usually calculated as the interest rate times the outstanding debt balance.

Interest Expense = Average Balance of Debt Obligation x Interest Rate.

You are free to use this image on your website, templates etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Interest Expense (wallstreetmojo.com)

How is Interest Expense Recorded in the Income Statement?

It is reported after the Operating income vs. EBITOperating Income Vs. EBITEBIT refers to the business's earnings during a period without considering the interest expense and the tax expense. In contrast, operating income is the income earned by a business organization from its principal revenue-generating activities, not considering non-operating income and expenses.read more, as shown in the income statement below.

Interest Expense Income Statement

source: Apple SEC filings

Example

Let us look at the below instance for a clear understanding of such an expense under the accrual method:

Assume a company borrows $125,000 on January 15 and agrees to pay interest amount on the 15th of every month from February 20. The loan indicates interest is 2% per month on the loan balance. The interest expense for month of January shall be [125,000 * 2%* 0.5 month] = $1,250.

Interest for month of February = $125,000 *2% * 1 = $2,500

Interest Expense Journal Entries

Let us look at the below examples of journal entries of interest expense:

Monthly Journal Entry –

Example 1.1

(This signifies cash amount paid out against interest recording)

Postpaid Journal Entry –

Example 1.2

(Interest payment is recorded as a liability and amount is to be paid)

Prepaid Journal Entry –

Example 1.3

(Cash paid in advance for interest payable in the future)

How to record in the Balance Sheet?

Where to record in Cash Flow Statements?

Interest and Tax Shield

The interest reduces the overall taxes in the income statement and thus can be used as a way to reduce tax liabilities (also called a tax shieldTax ShieldTax shield is the reduction in the taxable income by way of claiming the deduction allowed for the certain expense such as depreciation on the assets, interest on the debts etc. It is calculated by multiplying the deductible expense for the current year with the rate of taxation as applicable to the concerned person.read more).

For example, a firm with no DebtDebtPretax income is a company's net earnings calculated after deducting all the expenses, including cash expenses like salary expense, interest expense, and non-cash expenses like depreciation and other charges from the total revenue generated before deducting the income tax expense.read more and EBT [Earnings Before Tax] of $2 million (tax rate @30%), the tax payable will be $600,000.

If the same firm assumes a debt and has an interest of say $500,000, the new Earnings before Profit would be $1.5 million [$2million – $500,000]. This will make their taxes payable $500,000 [$1.5mm*30%].

Thus, there is a tax shield of $600,000 – $500,000 = $100,000.

Net Interest Expense

Net

source: Colgate SEC filings

Net interest expense is the Total Interest net of any interest income that a company receives on Investments.  On a financial statementA Financial StatementFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more, the income can be listed separately from expenses or provide a net interest number, which is either positive or negative.

This has been a guide to what is Interest Expense in the Income Statement and its meaning. Here we discuss how to record interest expense in income statement & balance sheet along with its journal entries. You may learn more about accounting from the following articles –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *