Understanding Accrued Interest
Accrued interest refers to the accumulated interest that a company has yet to pay or receive despite already being recorded in the books of accounts.
When a company acts as a lender, accrued interest is referred to as interest income, while for borrowers, it is termed interest expense.
These items are recorded in the balance sheet and the income statement as interest payable or interest receivable.
This accounting approach is typically followed under the accrual method.
Accrued interest is commonly used when accounting for the accumulated interest in bonds.
It represents the interest that accrues between the two interest payment dates by the issuer.
Difference Between Accrued Interest and Regular Interest
The critical distinction between accrued and regular interest lies in the timing of the interest payment.
If the interest is paid immediately after it is incurred, it will be generally recorded in the books of accounts.
However, the interest will be accrued if the borrower does not make immediate payment.
Accounting Treatment for Accrued Interest
When interest is not paid immediately, the accounting treatment varies as the interest becomes an asset or liability depending on the situation.
When the interest is paid to the lender by the company, the amount is reduced from the cash or bank balance, offsetting the balance in the interest payable account.
When the company is the lender, the accounting treatment is the opposite.
On the date when the interest income is expected to be received, an entry is made into the interest income account, and the accumulated amount of interest owed to the company is recorded as an asset in the balance sheet under the interest receivable account.
The accounting treatment for regular interest received is relatively straightforward.
The bank or cash accounts are debited, while the interest receivable account is credited.
In the case of interest expense, the interest payable account is debited, and the cash or bank accounts are credited.