What Is Interest Payable?
Interest Payable is the amount of interest expenses that have been incurred at a point but are yet to be paid. It is one of the forms of liability account that contains information about the interest payments accumulated over time and is scheduled to be paid in future.
Interest payable on balance sheet tells firms and keeps them alarmed about the financial obligations they have to fulfill. If any interest incurs after the date at which the interest payable is recorded on the balance sheet, that interest wouldn’t be considered.
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Interest Payable Explained
Interest payable, as the name suggests, accounts for the accumulated interest amount that a firm is yet to pay. It is a current liability for any organization, which is committed to pay back the amount owed to lenders. The accumulated interests are quite commonly recorded when one deals with a bond instrument. These accounts are maintained as part of the accrual accounting process.
The balance sheet or journal entry for interest payable enables firms to check and track their financial obligations and be prepared to bear them as and when scheduled. Based on these pieces of information, the financial statements are created. The interest expenses yet to be paid off by the time the balance sheet is prepared are recorded by the firm. Anything beyond that is discarded and left to be recorded in the next fiscal year.
When businesses keep track of the interest expenses, it ensures they pay them on time. In case, the accrued interest payment figure over a period indicates a high increase, it would mean delayed paying offs. Thus, when these payments are monitored, the firms make sure there is no delayed payment and the amount owed to lenders are paid to avoid any huge increase in the accumulated interest payment figures.
The interest payable account is maintained under the generally accepted accounting principles (GAAP).
How To Calculate?
When it comes to calculating the interest payment figures, there is no specific interest payable formula. For this calculation, the normal mathematical equation to calculate the interests is used. However, there is a series of steps that must be followed to ensure the calculation is done accurately.
Let us check out the steps of calculation of interest payable below:
Step 1: Identifying current payables
This includes considering the notes payable, which is the amount that an individual or entity plans to borrow. This allows the businesses to be more accurate while calculating the interest expense for the period.
Step 2: Converting the rate of interest
The next step is to convert the rate of interest from percentage to decimal. This makes calculating the interest payments easier. Thus, once the firms are aware of the rate of interest at which the loans are available, they can calculate the value, converting the interest rate into a decimal form.
Step 3: Finding out the time period
In the calculation of interest payable, it is important to know the time for which the principal amount has been borrowed. If the entities want to know how much they would require paying for specific number of months, they can divide the annual interest figure by 12.
Step 4: Computing periodic interest rate
Dividing the interest rate in the decimal form by the time period helps obtain the periodic interest rate.
Step 5: Calculating interest payable
One can calculate the interest payable by multiplying the amount to be borrowed or already borrowed with the period rate of interest.
Let us consider the following instances to see the interest payable definition and also see how it works:
Let’s say that Company Tilted Inc. has interest incurred of $10,000 for ten months, and the company needs to pay $1000 per month as interest expense ten days after each month ends. The interest started to incur on 10th October 2016.
The balance sheet was prepared on 31st December 2016. The company has already paid $3000 as interest expenses for September, October, and November. On the balance sheet, the company could only show “interest payable” of $1000 ($1000 for December). And the rest of the amount (i.e., $6000) wouldn’t take place on the balance sheet.
The most crucial part is that it is entirely different from 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.. When a company borrows an amount from a financial institution, it must pay an interest expense. This interest expense comes in the income statement. However, a company can’t show the entire amount of interest expense on the balance sheet. It can only show the interest amount that’s unpaid until the reporting date of the balance sheet.
Let’s say that Rocky Gloves Co. borrowed $500,000 from a bank for business expansion on 1st August 2017. The interest rate was 10% per annum, and they needed to pay the interest expense 20 days after each month ended. Find out the company’s interest expense and the interest payable as of 31st December 2017.
First, let’s calculate the interest expense on loan.
The interest expense on the loan would be = ($500,000 * 10% * 1/12) = $4,167 per month.
Now, since the loan was taken on 1st August 2017, the interest expense that would come in the income statement of the year 2017 would be for five months. If the loan were taken on 1st January, then the interest expense for the year would have been for 12 months.
So, in the income statementIn The Income StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements., the amount of interest expense would be = ($4,167 * 5) = $20,835.
The calculation of interest payable would be completely different.
Since it is mentioned that the interest for the month is being paid 20 days after the month ends, when the balance sheet is prepared, the interest that is not being paid would be only in November (not December). And also, the interest expense that needs to be paid after December 31st won’t be considered, as we discussed earlier.
So, the interest payable would only be $4,167.
Gigantic Ltd. has taken a loan of $2 million from a bank. They have to pay 12% interest per annum on the loan. The amount of interest should be paid quarterly. How would we look at interest expense and interest payable?
In the above example, everything is similar to the previous examples that we have worked out. The only difference in this example is the period when the interest expense has to be paid. Here it is every three months.
First, let’s calculate the interest expense for a year.
The interest expense for a year would be = ($2 million * 12%) = $240,000.
If we calculate the interest expense for every month, we would get = ($240,000 / 12) = $20,000 per month.
At the end of the first month, as the company accrues $20,000 in interest, the company would debitDebitDebit represents either an increase in a company’s expenses or a decline in its revenue. $20,000 as interest expense and credit the same amount as the interest payable balance sheet.
At the end of the second month, the company would pass the same entry, and as a result, the interest payable account balanceAccount BalanceAccount Balance is the amount of money in a person's financial account, such as a savings or checking account, at any given time. Furthermore, it can refer to the total amount of money owed to a third party, such as a utility company, credit card company, mortgage banker, or other similar lender or creditor. would be $40,000.
At the end of a quarter, the company would pass the same entry, and the balance in the interest payable account would be $60,000 (until the interest expenses are paid).
The moment the interest expenses are paid, the interest payable account would be zero, and the company would credit the cash account by the amount they paid as interest expense.
How To Record?
Interest expense is a type of expense. And whenever expense increases for the company, the company debits the interest expense account and vice versa.
Interest payable balance sheet is a type of liability. As per the rule of accountingRule Of AccountingAccounting rules are guidelines to follow for registering daily transactions in the entity book through the double-entry system. Here, every transaction must have at least 2 accounts (same amount), with one being debited & the other being credited. , if the company’s liability increases, we credit the account, and when the liability decreases, we debit the account
Here’s the journal entry the company passes for interest expense and interest payable on the balance sheet.
When the interest payable is being accrued but not being paid, the company passes the following journal entry –
Interest expense A/C …….. Dr
To Interest Payable A/C
Since the expense gets increased for the company in the form of interest expense, the company debits the interest expense account. And at the same time, it also increases the company’s liability until the interest payment is made; that’s why interest payable journal entries are credited.
When the interest expense is paid, the company passes the following entry –
Interest Payable A/C ……..Dr
To Cash A/C
At the time of payment, the company will debit the payable interest account because, after payment, the liability will be nil. And here, the company is crediting the cash account. Cash is an asset. When a company pays out cash, cash decreases, that’s why cash is being credited here.
After passing this entry, we get a net entry –
Interest Expense A/C …….Dr
To Cash A/C
Interest Payable vs Interest Expense
Interest payable and interest expense are terms that are most often confused in their usage. Though they are meant for serving almost same objectives, there are differences that must be known to firms and individuals using them.
The pointwise differentiation between the two are as follows:
- While interest payable signifies current liabilities for the interest owed ar a specific point in time, interest expenses cover total interest payments for loans and are recorded in the income statement.
- The former reflects the interest payments that are still due and are yet to be paid, while the latter reflects the total expense, both interest outstanding and interest already paid.
- Interest payable is recorded as a liability on the balance sheet. On the contrary, interest expense is the total amount of interest to be paid, which becomes a debt.
This has been a guide to what is Interest payable. We explain the concept along with how to calculate it, vs interest expense, examples & how to record it. You may also look at other accounting articles –