Accrued Interest

Accrued interest builds up over time before the actual payment or receipt takes place. It applies to loans, deposits, bonds, and other interest-bearing financial instruments.

• Borrowers record unpaid accrued interest as an expense and liability.
• Lenders record interest earned but not received as income and an asset.
• Accrued interest payable is generally shown as a current liability.
• Accrued interest receivable is generally shown as a current asset.
• Bond buyers may need to compensate sellers for interest earned before the sale date.
• Accounting entries ensure interest is recorded in the period in which it arises.

Accrued interest refers to interest that accumulates over time but has not yet been paid or received. It applies to both borrowings and investments.

For borrowers, accrued interest is the unpaid interest owed on a loan. For investors or deposit holders, it is the interest earned but not yet credited or received.

For example, suppose interest is paid on the 20th of every month and the accounting month ends on the 30th. The interest earned from the 21st to the 30th is accrued interest because it has been earned but not yet received.

From an accounting perspective, accrued interest may be recorded as either income or an expense:

Accrued interest is also shown on the balance sheet. Interest that is due to be received is generally recorded as a current asset, while interest due for payment is generally recorded as a current liability.

Accrued interest is recorded throughout the accounting process. It appears in journal entries, the statement of profit and loss, and the balance sheet.

An adjusting journal entry is passed at the end of the accounting period to record interest that has been earned or incurred but not yet settled.

In the statement of profit and loss, interest that is payable is recorded as an outstanding expense. Interest that is receivable is recorded as outstanding income or revenue.

In the balance sheet:

• Accrued Interest Receivable is generally recorded as a current asset.
• Accrued Interest Payable is generally recorded as a current liability.

These amounts are usually classified as current because they are commonly settled within one year.

Additional read: What are Assets

Consider Company P, which takes a loan of ₹12 lakh from Bank X at an annual interest rate of 10%.

The monthly instalment is due on the 5th of each month. Assuming a 30-day month, the monthly interest and accrued interest may be represented as follows:

The ₹8,333 represents the interest accumulated over 25 days before the monthly instalment becomes payable.

It is recorded as an interest expense and a liability until the payment is made.

Accrued interest also applies to bonds. Bond interest is commonly paid at fixed intervals, such as annually or half-yearly.

When a bond is sold between two interest payment dates, the seller has held the bond for part of the interest period. The seller is therefore entitled to the interest earned up to the sale date.

The buyer pays this accrued interest to the seller in addition to the agreed price of the bond. On the next interest payment date, the buyer receives the full interest payment from the bond issuer.

This arrangement ensures that both the buyer and seller receive interest for the period during which they owned the bond.

Additional read: Capital Adequacy Ratio

Suppose B owns a bond with a face value of ₹1 lakh and a fixed annual interest rate of 10%. Interest is paid once a year on December 31.

A purchases the bond from B on July 1, 2024. B held the bond from January 1 to June 30, 2024, and is therefore entitled to six months of accrued interest.

A pays B ₹1,05,000, which includes the bond’s face value and ₹5,000 of accrued interest.

On December 31, 2024, A receives the full annual interest payment of ₹10,000 from the bond issuer. The ₹5,000 paid to B represents the portion earned before A purchased the bond.

Accrued interest is an important part of accrual accounting. It ensures that interest income and expenses are recorded during the period in which they are earned or incurred, rather than when the related cash payment occurs.

Recording accrued interest payable and receivable also supports accurate financial reporting. It helps businesses follow the revenue recognition concept and the matching principle while presenting their assets, liabilities, income, and expenses more clearly.