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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.
How to calculate accrued interest
To calculate accrued interest, you need the principal amount, the interest rate, and the time period for which the interest has accrued. Here is the formula used:
Accrued interest = Principal x Interest rate x Time period
Where principal is the initial amount on which interest is calculated, interest rate is expressed as a decimal (e.g 5% = 0.05), and the time period is expressed in years (e.g. 6 month = 0.5 year)
Example of accrued interest
Assume you have a principal amount of £1,000 with an annual interest rate of 6%, and you want to calculate the interest accrued over three months.
- Principal: £1,000
- Interest rate: 6% or 0.06
- Time period: 3 months or 3/12 years = 0.25 years
Accrued interest = 1000 × 0.06 × 0.25 = 15
So, the accrued interest for three months would be £15.
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