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. Every firm needs money for financing its operations from a bank and pay a small fee based on the amount borrowed until is repaid. These are costs incurred by the entity for borrowed funds shown on the income statement.

Interest expense in the Income statement is usually calculated as the interest rate times the outstanding debt balance. These expenses on the income statement highlight interest accrued during the period covered by the financial statements and not the interest amount paid over the time period. While such expenses are tax-deductible for firms, with respect to an individual, the purpose and jurisdiction of the loan are applicable.

Formula

Below is the formula to calculate interest expense.

Interest Expense Journal Entries

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

Monthly Journal Entry –

(This signifies cash amount paid out against interest recording)

Postpaid Journal Entry –

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

Prepaid Journal Entry –

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

How is Interest Expense Recorded in Balance Sheet?

• Interest accrued but not paid would be recorded under Current Liabilities of the Balance Sheet (as interest payable)
• Interest paid in advance will be recorded within the section of Current Assets as a Prepaid item.

Where is Interest Expense Recorded in Cash Flow Statements?

• As the net profit or loss reported by the firm’s cash flow statement includes this expenses the business has paid during a given time period, the amount paid appears as a separate line item on the company’s cash flow statement and the appropriate this expense will appear under the income statement.
• The interest amount paid on loans (short term and long term debt) is recorded under Operating activities in the cash flow. However, the principal amounts borrowed and that repaid are separately included under financing activities. Since loan amounts are borrowed money and not an income from the sale of goods or services, they are a part of the cash flow statement but not the income statement.

Interest and Tax Shield

Interest  reduces the overall taxes in the income statement and thus can be used as a way to reduce tax liabilities (also called as tax shield).

For example, a firm with no Debt 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

source: Colgate SEC filings

Net interest expense is the Total Interest net of any interest income received on Investments.  On a financial statement, the income can be listed separately from expenses or provide a net interest number which is either positive or negative.

Recommended Articles

This has been a guide to what is Interest Expense in the Income Statement. Here we discuss interest expense formula, journal entries along with its practical examples. You may learn more about accounting from the following articles –

• Purpose of Cash Flow Statements
• Examples of Current Liabilities Formula (with Excel Template)
• Software AG Cash Flow Statement Example
• Formula of Interest Expense
• Financing Activities
• Explain Income Summary Account
• Equity vs Fixed Income – Compare
• What is Capitalized Interest?
• Calculate Imputed Interest