Accrued interest

Definition

Accrued interest refers to the interest that has been earned but not yet received or paid. It’s an interest that has been recognised in the books but has not yet been physically exchanged between the parties involved.

What is accrued interest?

To record accrued interest, a company will typically make an adjusting journal entry, debiting (increasing) an interest expense account and crediting (increasing) an accrued interest liability account.

Accrued interest is crucial for accurate financial reporting. It ensures that a company’s financial statements reflect all the expenses incurred or revenue earned in a given period, even if cash transactions haven’t taken place yet.

Accrued interest is significant for both borrowers and lenders, as it helps ensure that financial statements accurately represent the financial position of a business at any given point in time.

Example of accrued interest

1. Loan issued:
   • On January 1st, XYZ Loans issues a loan of $50,000 to a borrower. The loan has an annual interest rate of 6%, and interest is to be paid at the end of each quarter.

   The accounting entry for this transaction is:

   $\text{Loans receivable}(Asset)=\; \$50,000$

   At this point, there is no accrued interest recorded because it hasn’t been earned yet.

2. End of the first quarter:
   • At the end of the first quarter, the borrower has not made an interest payment yet, but interest has been earned on the outstanding loan balance for the quarter.

   The accounting entry for the accrued interest is:

   Interest receivable (Asset) = $50,000 × (6%?/4) = $750

   $\text{Interest income}(Revenue)=\; \$750$

3. Interest payment received:
   • On April 15th, the borrower makes an interest payment of $750 for the accrued interest from the first quarter.

   The accounting entry for the interest payment is:

   $\text{Cash}(Asset)=\; \$750$

   $\text{Interest receivable}(Asset)=\; -\$750$

   This entry reflects the cash received for the interest payment and reduces the accrued interest asset.