What is Accrued Interest?
Accrued Interest refers to the amount of interest that has been earned or incurred on a financial asset or liability but has not yet been received or paid. Under accrual accounting, this interest is recognized in the period it is earned or owed, even if cash settlement occurs later.
Definition
Accrued Interest is the interest expense or income that has accumulated over time but has not yet been paid (for borrowers) or received (for lenders) as of the balance sheet date.
Key Takeaways
- Accrued Interest applies to both loans and investments.
- Recorded as a liability when owed and as an asset when receivable.
- Ensures accurate matching of income and expenses under accrual accounting.
- Common in bonds, savings accounts, loans, and other interest-bearing instruments.
- Adjusting entries are made at period-end to reflect the interest accrued.
Understanding Accrued Interest
Interest accrues daily or periodically based on the principal, interest rate, and time elapsed. Even if payments occur monthly, quarterly, or annually, the earned or owed interest accumulates continuously.
For example, if a company issues bonds with semiannual interest payments, the interest expense builds up daily between payment dates. At each month-end, the company records the interest that has accrued to date to ensure financial statements reflect true liabilities and expenses.
Accrued interest appears as an interest receivable (asset) for the lender and as an interest payable (liability) for the borrower. It is reversed when the payment or receipt is made in the following period.
Formula (If Applicable)
Accrued Interest = Principal × Interest Rate × (Days Accrued ÷ 365)
Where:
- Principal: The outstanding loan or investment balance.
- Interest Rate: Annual rate applied to the principal.
- Days Accrued: Number of days since last interest payment.
Real-World Example
A company holds a $100,000 bond earning 6% annual interest, with semiannual payments. At the end of March, three months (or 90 days) of interest have accrued since the last payment in December.
Accrued Interest = $100,000 × 6% × (90 ÷ 365) = $1,479.45
The company records:
- Debit: Interest Receivable $1,479.45
- Credit: Interest Income $1,479.45
For the bond issuer, the same amount would be recognized as an Interest Expense and Interest Payable.
Importance in Business or Economics
Accrued interest ensures accurate financial reporting and interest expense recognition, maintaining compliance with accrual accounting standards. It helps:
- Reflect true profitability and liabilities at any reporting date.
- Align financial statements with the matching principle.
- Provide clarity on investment income and borrowing costs.
Economically, accrued interest plays a role in bond valuation, portfolio performance analysis, and interest rate policy effects across financial markets.
Types or Variations
- Accrued Interest Receivable: Interest earned but not yet received (asset).
- Accrued Interest Payable: Interest incurred but not yet paid (liability).
- Bond Accrued Interest: Interest accumulated between coupon payment dates.
- Loan Accrued Interest: Interest accumulating on outstanding loan balances.
Related Terms
- Accrual Accounting
- Interest Expense
- Interest Income
- Bond Yield
- Matching Principle
Sources and Further Reading
- Financial Accounting Standards Board (FASB): https://www.fasb.org
- Investopedia – Accrued Interest: https://www.investopedia.com/terms/a/accruedinterest.asp
- IFRS Foundation – Financial Instruments and Interest Recognition: https://www.ifrs.org
Quick Reference
- Category: Asset (receivable) or liability (payable).
- Formula: Principal × Rate × (Days ÷ 365).
- Purpose: Match interest income/expense with the correct period.
- Common Uses: Loans, bonds, and savings accounts.
- Effect: Ensures accurate period-end reporting.
Frequently Asked Questions (FAQs)
Is accrued interest an asset or a liability?
It depends on context — it’s an asset for the lender and a liability for the borrower.
When is accrued interest recorded?
At the end of each accounting period, before financial statements are finalized.
How is accrued interest different from prepaid interest?
Accrued interest is owed but unpaid; prepaid interest is paid before it’s due.
Why is accrued interest important?
It ensures accurate recognition of income and expenses in the period they occur, supporting transparent reporting.
