Accrued Interest

Accrued interest is the amount of interest earned on a debt but not yet collected. Interest accumulates from the date a loan is issued or when a bond's coupon is made. 

Accrued interest is calculated based on the last day of the accounting period. For example, if 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 (21st to the 30th) of interest. Accrued interest is reported on the income statement as a revenue or expense. Alternatively, the portion of revenue or expense yet to be paid or collected is reported on the balance sheet as an asset or liability. Because accrued interest is expected to be received or paid within one year, it is often classified as a current asset or current liability.

The application of accrued interest is a result of accrual accounting which counts economic events when they occur regardless of receipt of payment. It is the method associated with the matching principle of accounting.  The matching principle states that revenues and expenses are realized when they occur rather than when payment is received or expended. The accrual principle differs from the cash accounting principle, which recognizes an event when cash or other forms of consideration are received.  To illustrate how the accrual principle works, consider a retailer selling a customer goods on credit in September.  According to the accrual principle, the transaction is to be recorded immediately in the accounts receivable account.  The transaction will also be accounted for as income for September although no payment was received for the transaction.  

Businesses typically record accrued interest at the end of an accounting period.  Two accounts on two separate financial statements are adjusted for accrued interest.  The interest expense account on the income statement is first debited by the total amount of accrued interest.  If a company has $5,000 in accrued interest, it would debit its interest expense account by $5,000.  The new balance would be the previous balance plus $5,000.  The interest payable current liability account on the balance sheet is credited by the same amount that the interest expense account is debited for.  Like the expense account, the interest payable account is increased by the recorded amount of accrued interest.  Therefore, the new balance will be the previous balance and the $5,000 accrued interest amount.  If no other accrued interest is added to the interest payable account, the balance will remain constant until a payment of interest is paid.