Definition of Accrued Interest
Accrued interest (Acc. Int) refers to the amount of interest that has been accrued on investments or borrowings, but the same has not been yet, and it is treated as financial gain or obligation depending upon whether it is accrued on the investments made or the amount borrowed by way of debentures or bonds and it is recorded in the accounts so as to follow the accrual system of accounting.
As per the accrual accounting system, the income that is incurred but not yet received or expense that is incurred but not yet paid is to be recorded in the accounts to reflect the true and fair view for the period mentioned. Acc. Int is the interest received on the investment, like fixed deposits, loans given, interest on bonds, etc., whereas Acc. Int can also be a liability like interest on the amount borrowed by way of debentures or bonds, etc. It follows the guidelines of generally accepted accounting principles like revenue recognition and the matching principle of accounting. It refers to the accumulated interest due for receipt of payment but not received or paid, as the case may be. It is recorded at the end of the accounting period i.e. on the balance sheet date, to reflect the true and fair view of the accounting.
Formula for Accrued Interest
For borrowings like debentures and bonds, the formula for Acc. Int is as under:
The formula for Acc. Int on investment
Acc. Int as on the last day of the financial year or as on the balance sheet date is calculated for the period it is due. For example, the interest for each quarter will be received on the 10th of the next quarter. So, the interest of last quarter, which accrued on the 31st of March, will be received on the 10th of April. Hence Acc. Int for last quarter i.e. Jan – March, is due and will be recorded in the accounts as Acc. Int.
Following are examples are given below:
The company borrows $ 70,000 from the bank and the annual interest rate is 5%. The amount is borrowed on 15-12-2019, where the payment of interest is monthly. The financial year of the company closes on 31st December. Calculate the Acc. Int to be recognized in the books of accounts at the closing of the financial year?
The period from December 15 to December 31 = 16 days
Acc. Int is calculated as
Accrued Interest = Borrowed Amount * Yearly Interest Rate / 365 * Period for Which Interest is Accrued
- Accrued Interest = $70,000 * 5% / 365 * 16
- Accrued Interest = $70,000 * 0.05 / 365 * 16
- Accrued Interest = $153 (appx)
|Yearly Interest rate||5%|
|Number of days in a year||365|
|Period for which interest is accrued||16|
Company A Ltd deposits in fixed deposits amounting to $ 50,000. The interest rate on fixed deposits is 6%. A fixed deposit is made on 01-02-2019 and matured on 31-03-2021. The company closes the books on 31st March every year. Calculate the Acc. Int on the fixed deposit?
The period from February 1 to March 31 = 59 days
Acc. Int is calculated as
Accrued Interest = Investment Amount * Yearly Interest Rate / 365 * Period for Which Interest is Accrued.
- Acc. Int = $50,000 * 6% / 365 * 59 days
- Acc. Int = $50,000 * 0.06 / 365 * 59
- Acc. Int = $485 (Appx)
|Yearly Interest rate||6%|
|Number of days in a year||365|
|Period for which interest is accrued||59|
Accrued Interest on Bonds
Bond is the debt obligation for the borrower, and it is an asset for the lender. Hence the lender is entitled to receive the interest on bonds. The interest on bonds is generally known as coupons and paid yearly, half-yearly, quarterly or as decided at the time of issuance of the bond. The bond is a negotiable instrument i.e. it can be transferred from one person to another person very easily, but there is a problem with respect to the interest at the time of sale i.e. when the bond is transferred, the interest accrued can also be paid to the seller by the buyer of the bonds. So, interest is calculated at the time of sale of such a bond. For example, there is a bond in which interest accrued from April to September will be received in October by the buyer. The seller wants to sell the bond in July. Hence apart from the bond’s market price, the buyer also has to pay the interest for three months to the seller, which he will receive from the organization in October.
Accrued Interest vs Regular Interest
- Acc. Int is the interest that gets due but has not been paid yet whereas regular interest is the interest that is paid or received and recorded in the books of accounts.
- Acc. Int is recognized in the accounts before the actual payment is made whereas regular interest is recorded only after the receipt.
- The payment or receipt cycle of Acc. Int is constant and decided before the investment or borrowing, and it cannot be changed, whereas the payment or receipt cycle of regular interest is flexible in nature and can be changed at any time as per mutual decision.
- Acc. Int is recorded as per the accrual accounting system, i.e. on a due basis, whereas the regular interest is recorded on a per receipt basis.
Acc. Int is the interest that gets due or accumulated but is not received or paid. Example of Acc. Int includes interest on fixed deposits, interest on bonds, interest on debentures, etc. The payment or receipt cycle of Acc. Int is pre decided and it is constant in nature. Bond being the negotiable instrument, can be transferred at any time, so in that case, the seller is entitled to receive the interest apart from sale proceeds. Acc. Int is different from a regular interest in terms of flexibility as the receipt or payment cycle of regular interest is customized and changed with mutual consultation. Acc. Int is recorded as per the matching concept and as per the accrual system of accounting. The calculation of Acc. Int is to be done up to the last day of the financial year.
This is a guide to Accrued Interest. Here we also discuss the definition and accrued interest on bonds along with different examples. You may also have a look at the following articles to learn more –