Accrued interest

Accrued Interest is a term used in accounting, finance, and investment to refer to the interest that has been incurred, but not yet paid. This concept is fundamental to the practice of accrual accounting, where revenues and expenses are recognized when they are incurred, not when cash is exchanged.

Definition

Accrued interest is the interest that adds up (accrues) on a loan or investment over a certain period of time, but has not yet been paid to the lender or received by the investor. It is calculated from the date of the last payment up to, but not including, the settlement date or transaction date.

Calculation

The calculation of accrued interest depends on the type of interest rate, the compounding period, and the time elapsed since the last payment or compounding period. For a simple interest rate, the formula is:

Accrued Interest = Principal x Rate x Time

Where:

• Principal is the initial amount of the loan or investment.
• Rate is the annual interest rate, expressed as a decimal.
• Time is the time period for which the interest is being calculated, usually expressed in years.

For a compound interest rate, the formula is more complex and depends on the frequency of compounding.

Accounting for Accrued Interest

In accrual accounting, accrued interest is recorded as an expense for the borrower and as revenue for the lender, even if no cash has been exchanged. This is done to match the expense and the revenue to the period in which they are incurred, in accordance with the matching principle.

The borrower records accrued interest as a debit to Interest Expense and a credit to Accrued Interest Payable, both of which are accounts in the general ledger. The lender, on the other hand, records it as a debit to Accrued Interest Receivable and a credit to Interest Revenue.

Accrued Interest in Bonds

In the context of bond trading, accrued interest is the interest that has been earned by the bondholder since the last interest payment date, but has not yet been received. The buyer of the bond pays the seller the purchase price plus the accrued interest, which will be returned to the buyer when the bond pays interest on the next payment date.

See Also

• Accrual
• Accruals and deferrals
• Accrual basis accounting
• Compound interest
• Simple interest
• Bond (finance)