Accrued interest refers to the interest that a company owes or is owed on a specific date for a debt or financial obligation that has not yet been received or paid.
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What Is an Accrued Interest?
Accrued interest is the accumulated amount of interest that a company has yet to pay or receive, however, it has already been recorded in the books of accounts. When a company is a lender, it is known as interest income; when the company is the borrower, it is known as an interest expense. These items are recorded in the balance sheet as well as the income statement as interest payable or interest receivable. This approach is only followed under the accrual method of accounting.
Accrued interest is also commonly used while accounting for accumulated interest in bonds, the interest usually builds up between the two date interest payment dates by the issuer.
Difference Between Accrued Interest and Regular Interest
There is only one crucial differentiator between accrued and regular interest and that is the time of the interest payment. If the interest was paid immediately after it was incurred, it will be recorded normally in the books of accounts. However, if the borrower does not pay immediately then the interest will be accrued.
Accounting Treatment for Accrued Interest
When interest is not paid immediately the accounting treatment changes as the interest becomes an asset or liability depending on the scenario. For example, if a company owes interest, then there will be an entry into the interest payable account in the balance sheet as a liability. The company will also record it as an expense since the expense was for the period when it was incurred and not when it was paid.
When the interest is paid to the lender by the company, the amount will be reduced from the cash or bank balance and will set off the balance in the interest payable account.
Taking the same scenario as an example, the accounting treatment would the exact opposite if the company was the lender. On the date at which the interest income is to be received, an entry into the interest income would be carried out and the accumulated amount of the interest owed to the company will be recorded as an asset in the balance sheet under the interest receivable account.
The accounting treatment for regular interest received on the other hand is fairly simple, the bank or cash accounts get debited whilst the interest receivable account gets credited. If an interest expense occurs then the interest payable account gets debited whilst the cash or bank accounts get credited.