What is accrued interest: Meaning, Calculation & Treatment in Accounts

Accrued interest is the interest that builds up on a loan or investment but hasn’t been paid or received yet. It helps match income and expenses to the right time period in the accounts.

Example: Raksha’s Lending Experience:

Raksha runs a small business and lent ₹5,00,000 to a factory on 1st April at 10% annual interest, with payments due every six months. By 30th June, even though she hadn’t received any money yet, ₹12,500 in interest had built up (₹5,00,000 × 10% × 3/12). 

She added this to her books as Interest Receivable and Interest Income, to show the earnings for that quarter. At the same time, the borrower recorded it as Interest Expense and Accrued Interest Payable. 

This made sure both sides showed the correct figures in their financial reports, even before the money changed hands. 

In this blog, you will learn the meaning of accrued interest, how to calculate it, and how to record it properly in the accounts.

How to Calculate Accrued Interest

To calculate accrued interest accurately, you need to use the right formula and understand the day-count conventions that affect the calculation.

Using this method ensures you correctly account for interest earned or owed over any period, keeping your financial records accurate and up to date.

Journal Entries & Adjusting Entries Treatment

When interest has been earned or incurred but not yet received or paid by the reporting date, businesses must make adjusting journal entries. This ensures the financial statements reflect the correct amount of interest income or expense for the period.

1. For the Lender (Accrued Interest Receivable)
 

• Scenario: Raksha lent ₹1,00,000 at 10% annual interest on 1st April. By 30th June (end of quarter), interest has accrued for 90 days, but payment is yet to be received.
   
• Accrued Interest Calculation:
  ₹1,00,000 × 10% × (90 ÷ 365) = ₹2,465.75
   
• Adjusting Journal Entry on 30th June:
   

This entry recognises the interest income earned but not yet received.

2. For the Borrower (Accrued Interest Payable)
 

• Scenario: The borrower owes the same interest to Raksha but hasn’t paid it by 30th June.
   
• Adjusting Journal Entry on 30th June:
   

This entry recognises the interest expense incurred but not yet paid.

3. When Interest is Paid/Received Later
 

• On the date of actual payment or receipt, the accrued interest account is reversed, and cash is recorded:
   

• Lender receives interest:

Borrower pays interest:
 

This method keeps the accounts accurate by matching interest income or expense to the period it relates to, even if the cash moves later.

Applications & Special Situations of Accrued Interest

Accrued interest shows up in different financial situations. Knowing these helps you keep your accounts right.

1. Buying or Selling Bonds Between Interest Dates

If someone buys or sells bonds between interest payment dates, the buyer pays the seller the interest earned so far. This way, the seller doesn’t lose money for the interest they earned but haven’t been paid yet.

• Example: Surbhi sells a bond worth ₹1,00,000 that pays 8% interest yearly, twice a year (on 1st January and 1st July). She sells it on 1st April. The buyer pays her interest for 3 months (January to April).
  
  Calculation:
  ₹1,00,000 × 8% × (3 ÷ 12) = ₹2,000

The buyer pays Surbhi ₹1,00,000 plus ₹2,000 for the interest.

2. Accrued Interest on Loans

Lenders note interest they have earned but not received yet. Borrowers record interest they owe but haven’t paid yet. This keeps accounts accurate.

3. Special Accounting Rules
 

• Companies match interest income or expense to the time it relates to, even if no cash has moved.
   
• They show accrued interest as either an asset (money owed to them) or a liability (money they owe).

Example: Bond Sale with Accrued Interest

Surbhi sells a ₹2,00,000 bond paying 6% interest yearly, with interest dates on 31st March and 30th September. She sells it on 30th June. Calculate the interest for 3 months (31st March to 30th June):

₹2,00,000 × 6% × (3 ÷ 12) = ₹3,000

The buyer pays ₹2,00,000 plus ₹3,000 to Surbhi.

Knowing these special cases helps you handle accrued interest the right way in your accounts.

Practical Tips for Handling Accrued Interest

Here are a few of the practical tips for handling accrued interest for your better understanding:
 

• Keep track of interest dates: Always note when interest payments are due to calculate accrued interest correctly.
   
• Use consistent day-count conventions: Follow the same method (e.g., Actual/365 or 30/360) throughout your accounts.
   
• Make timely adjusting entries: Record accrued interest in your books at the end of each reporting period to keep financial statements accurate.
   
• Double-check transactions during bond sales: Ensure accrued interest is included when bonds change hands between payment dates.
   
• Use software tools: Many accounting systems can calculate accrued interest automatically, reducing errors.
   
• Communicate clearly with buyers/sellers: Make sure both parties understand the accrued interest amount in bond transactions.

Knowing these special cases and tips will help you manage accrued interest smoothly and accurately in your accounts.

Conclusion

Accrued interest ensures that interest income and expenses are recorded in the right period, even if the cash hasn’t been received or paid yet. This helps businesses and investors keep their financial records accurate and up to date, giving a true picture of their financial health.

FAQs
 

1. Why do we need to record accrued interest?

We record accrued interest to match income and expenses to the right time period. This keeps financial reports fair and accurate.

2. Who records accrued interest, the borrower or the lender?

Both do. The lender records accrued interest as income they earned but haven’t received. The borrower records it as an expense they owe but haven’t paid yet.

3. How do we calculate accrued interest?

Multiply the principal by the interest rate and the fraction of the year that has passed (days divided by 365 or 360), like this:
Accrued Interest = Principal × Rate × (Days ÷ Days in year)

4. What happens if bonds are sold between interest payment dates?

The buyer pays the seller the accrued interest earned so far. This makes sure the seller isn’t shortchanged on interest they earned before selling.
 

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LoansJagat Team

‘Simplify Finance for Everyone.’ This is the common goal of our team, as we try to explain any topic with relatable examples. From personal to business finance, managing EMIs to becoming debt-free, we do extensive research on each and every parameter, so you don’t have to. Scroll up and have a look at what 15+ years of experience in the BFSI sector looks like.