BAJAJ BROKING
February 20, 2025
5 mins read
Accrued interest is that interest which is incurred but is yet to be received or paid. It occurs due to mismatches between the actual time of paying or receiving interest and the time Read more..of the preparation of books of accounts. Suppose you lend money to someone and the interest is payable on December 31, but you finalise your accounts on March 31. When you finalise your books on March 31, you will record the 3 months interest (from January 1 to March 31) as an accrued interest. It will be treated as an income in your P&L Account as an asset in your Balance Sheet. Read less
Accrued interest means an amount of interest that is incurred as of a certain date but is yet to be paid or received. Let us say you take a loan, which makes you pay interest annually.
Hence, you will pay interest on it once in a year. But, if you are making your books of accounts in the middle of the year, how will you treat the interest payable on this loan?
Whatever interest you owe to the lender for the duration between the last payment date and the date on which you are preparing your accounts will be recorded as accrued interest. If you are keen on this topic, do read this blog, as it explains what accrued interest is and what interest accrual means in great detail.
Accrued interest is a famous accounting concept, which means the amount of interest that is incurred but is yet to be paid/received as of a specific date. Let us say that you have taken a loan on which you have to pay interest once a year. While you pay the interest only once a year, every day you owe a certain amount to your lender on the account of interest, which is known as accrued interest.
The terms of the contract may require you to pay interest only once a year but you owe interest to the lender every day you use his loan for your purpose. In this case, since you are a borrower, you have accrued interest expense. But, for your lender, it is accrued interest income.
The term “accrued” means accumulated. Let us consider the example given above. Every day you use the loan provided by a lender, the interest payable on it gets accumulated. Hence, from an accounting perspective, such accumulated or accrued interest is your liability and your lender’s asset. Having learnt what accrued interest is and what interest accrual means, let us delve deeper into this topic.
The two concepts “Accrual Accounting” and “Accrued Interest” are inherently related to each other. Under the accrual system of accounting, a company records revenue when a sale is made or when a product is sold and delivered to a customer.
In this system of accounting, it does not matter when a customer actually pays for the goods sold to him. If a company has delivered a product/service to a customer, it will record a sale.
Similarly, if a business receives inputs from a supplier, it has to record purchases under the accrual system even if it has not paid for the inputs yet. The actual payment is not important in this system. This system works on the principle of what “ought” to happen.
If a business delivers products to its customer, it ought to receive money and hence it will record revenue. The concept of “Accrued Interest” works on the same principle.
When a firm is obligated to pay interest to its lender because it has borrowed money from it, it will have to record “accrued interest” as an expense even if it has not paid the interest yet. Similarly, the firm’s lender will record “accrued interest” as an income even if he has not received it yet.
Let us say that a company called “XYZ Corp” takes a loan from a bank amounting to ₹ 10 lakh at an interest of 10% per annum. While the interest is due on June 30 every year, XYZ Corp’s financial year ends on March 31.
XYZ Corp’s financial year is from April 1 to March 31, but the financial year for the loan is from July 1 to June 30. The interest for the full 12 months can be calculated as follows:
Interest Payable for 12 months = 10,00,000 * 10% = ₹ 1,00,000
However, in this case, XYZ Corp would have paid interest on June 30 of the previous year, which means it has yet to pay interest for 9 months (July 1 to March 31) as of March 31 this year. Remember that ₹ 1,00,000 is the interest payable for 12 months.
Therefore, its accrued interest will be ₹ 1,00,000*(9/12) = ₹ 75,000
In its profit and loss account, XYZ Corp will show an accrued interest expense of ₹ 75,000 as of March 31 this year. And, in its balance sheet, it will show an accrued interest liability of ₹ 75,000.
Accrued interest is an extremely important concept when buying or selling a bond. Let us understand how it works with the help of a simple example. Suppose X buys a bond with a face value of ₹ 50,000 and 8% fixed annual interest from Z on January 1, 2024. The interest on the bond is paid out on June 30 every year.
Now, when Z sells the bond to X on January 1, he should earn the interest on it from June 30 to December 31, 2023 because he was the owner of the bond for that period, but the interest will be paid on June 30, 2024. Therefore, the interest for the period of 6 months (from July 1 to December 31) should be added to the face value of the bond.
At the rate of 8% for a year, six months interest on ₹ 50,000 should amount to ₹ 2,000. Hence, X should pay ₹ 52,000 on January 1, 2024 to Z to buy the bond.
Whether you are about to open a demat account to begin trading or are a seasoned investor in the market, you should understand the concept of accrued interest because it will help you analyse the financials of companies well.
There are firms, which have a significant amount of accrued interest recorded in their profit & loss account and balance sheet. You need to know how it affects their business and financials before investing in them.
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This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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Whether accrued interest is an asset or a liability varies from case to case. If you provide a loan to a borrower, the loan is an asset for you and even the accrued interest on it is an asset. However, if you borrow from someone, the loan and the accrued interest on it are your liabilities.
If you borrow funds, then accrued interest is recorded as an expense in your profit & loss account and as a liability in your balance sheet. However, if you lend money, accrued interest is recorded as an income in your P&L account and as an asset in your balance sheet.
Due to timing mismatches, interest is accrued on investments and loans. In such cases, there is a mismatch between when interest is paid/received and when the books of accounts are prepared.
When you buy a bond that has an accrued interest, you have to pay that interest to the seller in most cases. On the interest payout date, you will receive the interest for the full period, but a part of it will effectively be a “refund” for the accrued interest you paid to the bond’s seller.
Accrued interest is paid or settled on the date of coupon payment. In the case of the purchase of a bond, the buyer has to pay the accrued interest to the seller on the date of the bond’s purchase.
Investors can make this calculation based on how much interest has accumulated since the date of the last payment. For example, if the interest payment date on a loan is December 31 and you are preparing the books of accounts on March 31, then three months’ interest will accumulate by March 31.
Earned interest means the interest income earned or generated on an investment. Accrued interest is the interest that is accumulated but not yet received or paid on a loan or an investment. On the other hand, paid interest refers to the interest actually paid or received.
Suppose you take a loan on which you have to pay ₹ 12,000 interest every year on December 31. But, your financial year is from April 1 to March 31. So, on March 31 when you finalise your accounts, you are obligated to pay 3 months’ interest which is ₹ 3,000, which you have not yet paid. Hence, ₹ 3,000 is your accrued interest.
Interest payable is the interest that is due to be paid on the next payment date. However, accrued interest is the interest that has been accumulated since the last payment date but has not been paid.
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