What is Interest Payable?
Interest Payable is the amount of expense that has incurred but not paid till now (the date at which it is recorded on the balance sheet of the company).
If any interest incurs after the date at which the interest payable is recorded on the balance sheet, that interest wouldn’t be considered.
Examples of Interest payable
Let’s see the following examples.
Let’s say that Company Tilted Inc. has interest incurred $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. It means that the company has already paid $3000 as interest expense for September, October, and November. That means, 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 into the balance sheet.
The most crucial part is that it is entirely different from interest expense. When a company borrows an amount from a financial institution, it needs to 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 that they needed to pay the interest expense 20 days after each month ends. Find out the interest expense of the company and also the interest payable as on 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 statement, the amount of interest expense would be = ($4,167 * 5) = $20,835.
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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 of only 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.
What journal entries to pass for interest payable?
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 accounting, if the liability of the company increases, we credit the account, and when the liability decreases, we debit the account.
Now, 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 liability of the company 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 interest payable 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 here cash is being credited.
After passing this entry, we get a net entry –
Interest Expense A/C …….Dr
To Cash A/C
Interest Expense vs. Interest Payable Example
Gigantic Ltd. has taken a loan of $2 million from a bank. They have to pay 12% interest per annum on 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 interest, the company would debit $20,000 as interest expense and credit the same amount as 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 balance 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, interest payable account would be zero, and the company would credit the cash account by the amount they paid as interest expense.
This has been a guide to what is an Interest payable balance sheet and its definition? Here we discuss the interest payable journal entries in accounting along with examples and explanation. You may also look at other accounting articles –