What is Accrued Interest? Understand The Concept With Examples

Understand all about accrued interest, how it grows over time on loans or investments.
Accrued Interest
3 min
14-April-2024

Financial instruments like loans and investments are essential for individuals and businesses. They enable the establishment of proper financial planning and accounting processes to realise financial goals.

What is accrued interest

Accrued interest is an important component of accounting. It refers to the interest that has accumulated — typically over a loan, but could be over other financial obligations — but has not been settled through payment. This means it is an outstanding amount, as the borrower hasn’t made the payment. Accounting necessitates that any expense or revenue be recorded as and when it happens. Thus, accrued interest entries are made even if the actual interest amount has not changed hands. The accrual accounting method is also of particular interest to investors and analysts, as it can give better insights into a business’s health than analysing the business through actual cash flow-based methods.

In accounting, it can take the form of an expense for a borrower and revenue for a lender. As a lender, the accrued interest entry would be under revenue, and as a borrower, accounting would put it under expenses.

Accrued interest is undoubtedly a vital element in accounting. However, it is also important to calculate bond interest. If you have purchased a bond, accrued interest refers to the amount that has accumulated since the last interest payout.

Accrued interest examples

Fixed deposit

For most Indians, the most popular investment instrument is a fixed deposit. This is because these deposits are secure and assure guaranteed returns. In addition to banks and non-banking financial institutions, post offices in India also offer the provision to book deposits with tenures ranging from 1-5 years. The range of post office FD interest rate is usually 6.90%-7.50%

Let us take the example of fixed deposits to understand what is accrued interest. Let us assume you have opened a term deposit with a 5% interest rate and Rs. 1 lakh as the principal amount. The interest payout will be annual, but you want to make a quarterly financial plan and statement. Here, the accrued interest will help you clarify the records in your financial books; even though you will not receive the interest, it is due in time. With accrued interest, we note that the quarterly interest owed to you will be Rs. 1,250. In the accounting books, interest revenue will be mentioned as Rs. 1,250 and accrued interest receivable as Rs. 1,250.

Bajaj Finance FD is a great investment option offering FD interest rates up to 8.85% per annum. With flexible payout options and tenures, you can control your returns and rest assured that your money is in safe hands.

Loan

Accrued interest is also commonly used to determine repayment liabilities for individuals and companies when they take out loans. Loans can help you manage cash flows and avoid premature FD withdrawals. Borrowing money comes with a defined interest rate and must be repaid within a specified period. As an example, let us assume you have taken out a loan for Rs. 1 lakh with an interest rate of 10%. The interest is to be paid annually, and the payment is due in a year. In this case, if you want to account for accrued interest semi-annually, you will have to enter it in the financial accounts as an interest expense of Rs. 5,000 for one 6-month period.

Bond market

Bonds are an essential part of an investor’s portfolio. In India, there are several kinds of bonds, like corporate bonds and government securities. The bond market operates this way: the issuer of bonds looks to raise money, and the investors can purchase bonds and earn a specified interest on the purchased bonds. A bond can also be traded in the market and sold to another interested buyer for profit. While the initial bond-issuing authority has raised capital, you can also make profits in multiple ways. The sale of a bond in the market is where the concept of accrued interest gains significance.

Let us assume that you have bought a government bond for Rs. 1 lakh at a rate of 6%, and the bond’s interest payout is annual. If you want to sell the bond for Rs. 1.1 lakh after 6 months, you will not be able to collect the interest at the end of the year. Thus, you can calculate accrued interest for the period you have held the bond so that the buyer of the bond can compensate you when they receive the full interest payout.

Conclusion

Accrued interest serves as a crucial component in accounting, lending, and investment scenarios, bringing clarity to financial obligations and potential earnings. Whether it is in the context of loans, bond markets, or any other financial instrument, accrued interest plays an important role in ensuring accurate financial records and facilitating informed decision-making for borrowers and lenders. By understanding the concept of accrued interest and its applications across various financial instruments, individuals and businesses can better navigate the complexities of financial planning and management, ultimately working towards their financial goals with clarity and efficiency.

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Disclaimer

As regards deposit taking activity of Bajaj Finance Ltd (BFL), the viewers may refer to the advertisement in the Indian Express (Mumbai Edition) and Loksatta (Pune Edition) furnished in the application form for soliciting public deposits or refer https://www.bajajfinserv.in/fixed-deposit-archives
The company is having a valid Certificate of Registration dated March 5, 1998 issued by the Reserve Bank of India under section 45 IA of the Reserve Bank of India Act, 1934. However, the RBI does not accept any responsibility or guarantee about the present position as to the financial soundness of the company or for the correctness of any of the statements or representations made or opinions expressed by the company and for repayment of deposits/discharge of the liabilities by the company.

For the FD calculator the actual returns may vary slightly if the Fixed Deposit tenure includes a leap year.