Accrued interest definition
/What is Accrued Interest?
Accrued interest is the amount of interest that has accumulated on a debt since the last interest payment date. The concept is typically used to compile the amount of unpaid interest that is either receivable to or payable by a business at the end of an accounting period, so that the transaction is recorded in the correct period. This approach is only used under the accrual basis of accounting.
Example of Accrued Interest
There is a $10,000 loan receivable at a 10% interest rate, on which a payment has been received that addresses the period through the 15th day of the month. To record the additional amount of interest receivable that was earned from the 16th to the 30th days of the month, the calculation is:
(10% x (15/365)) x $10,000 = $41.10 accrued interest
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How to Account for Accrued Interest
In the following sub-sections, we show how to account for accrued interest by either party, note the need for reversing entries, and point out why an accrual is not needed for immaterial amounts.
Accounting by the Payment Recipient
The amount of accrued interest for the recipient of the payment is a debit to the interest receivable (asset) account and a credit to the interest revenue account. The debit is rolled into the balance sheet (as a short-term asset) and the credit into the income statement.
Accounting by the Paying Entity
The amount of accrued interest for the entity owing the payment is a debit to the interest expense account and a credit to the accrued liabilities account. The debit is rolled into the income statement and the credit into the balance sheet (as a short-term liability).
Use of Reversing Entries
In both cases, these are flagged as reversing entries, so they are reversed at the beginning of the following month. Thus, the net effect of these transactions is that revenue or expense recognition is shifted forward in time.
Accruals for Immaterial Amounts
It is not useful or necessary to record accrued interest when the amount to be accrued is immaterial to the financial statements. Recording it under these circumstances only makes the production of financial statements more complicated than should be the case, and introduces the risk of errors.