Accrued Interest Definition, Formula, and Examples

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Accrued interest is an important consideration when purchasing or selling a bond. Bonds offer the owner compensation for the money they have lent, in the form of regular interest payments. These interest payments, also referred to as coupons, are generally paid semiannually. When someone purchases a bond, they’re basically loaning accrue interest meaning money to the government or company they purchased it from. Accurate and timely accrued interest accounting is important for lenders and for investors who are trying to predict the future liquidity, solvency, and profitability of a company. Accrued interest normally is recorded as of the last day of an accounting period.

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If you have a regular interest loan, also called a simple interest loan, the payment due will always be the same. A regular interest agreement establishes a set interest rate and usually a payment amount that spans the term of the loan. Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer.

At the time an investor converts a convertible bond, there will usually be one last partial payment made to the bondholder to cover the amount that has accrued since the last payment date of record. Under the bond perspective, accrued interest refers to the part of the interest that has been incurred but not paid since the last payment day of the bond interest. Bonds can be traded in the market every day, while their interests are usually paid annually or semi-annually.

Accrual Interest in Accounting

Accrued interest is calculated as of the last day of the accounting period. For example, assume interest is payable on the 20th of each month, and the accounting period is the end of each calendar month. The month of April will require an accrual of 10 days of interest, from the 21st to the 30th. When buying bonds in the secondary market, the buyer will have to pay accrued interest to the seller as part of the total purchase price. However, since the buyer did not earn all of the interest accrued over this period, they must pay the bond seller the portion of the interest that the seller earned before selling the bond.

Loan Financing Rate Assumptions

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It would not be correct to wait until the due date of 28 February to recognize the interest revenue earned through 31 December 2019.

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The company owes the bank interest on the vehicle on the first day of the following month. The company has use of the vehicle for the entire prior month, and is, therefore, able to use the vehicle to conduct business and generate revenue. The company’s journal entry credits bonds payable for the par value, credits interest payable for the accrued interest, and offsets those by debiting cash for the sum of par, plus accrued interest. Even though no interest payments are made between mid-December and Dec. 31, the company’s December income statement needs to reflect profitability by showing accrued interest as an expense. Specifically, transactions under accrual accounting must be recorded on the date of occurrence (i.e. once earned), irrespective of whether cash payment was received. At the maturity date, the cash account is debited for the entire value of the loan.