Accrued Interest

Definition of Accrued Interest

Accrued interest is the amount of interest that has accumulated on a financial investment but has not yet been paid out to the investor or received by the lender. This term is often used in bond markets, helping both bondholders and issuers gauge the exact balance of interest obligation up to a certain accounting date.

When companies or individuals hold or owe investments such as bonds, loans, or other debt securities, accrued interest needs to be recorded to properly present the financial liabilities or income. This concept ensures that the financial statements accurately reflect the financial position at any given time.

Examples of Accrued Interest

1. Savings Account:
   • Suppose you earn 4% annually on a $1,000 deposit in a savings account. After 15 days, the interest accrued would be calculated as follows: \[ \text{Accrued Interest} = \frac{0.04 \times 1000 \times 15}{365} = $1.64 \]
2. Bond Investment:
   • Assuming you hold a bond with a face value of $5,000 and an annual coupon rate of 5%, and it has been 90 days since the last interest payment: \[ \text{Accrued Interest} = \frac{0.05 \times 5000 \times 90}{365} = $61.64 \]
3. Mortgage Loan:
   • For a mortgage of $300,000 with an annual interest rate of 3.5%, the monthly interest accrued will be: \[ \text{Accrued Interest} = \frac{0.035 \times 300000}{12} = $875 \]

Frequently Asked Questions

Q1: How is accrued interest different from regular interest?

• A1: Regular interest is the total interest amount paid or received over time as per the agreement, while accrued interest is the portion of that total interest which has accumulated but is unpaid at a given moment.

Q2: How is accrued interest calculated?

• A2: It is calculated using the formula: \[ \text{Accrued Interest} = \text{Principal} \times \text{Rate} \times \left( \frac{\text{Time Period}}{\text{Total Period}} \right) \] where the time period is the number of days/months since the interest was last paid or received, and the total period might be a year or any specific payment cycle.

Q3: Why is it important for businesses to account for accrued interest?

• A3: Accurate accounting of accrued interest ensures that financial statements present a true and fair view of a business’s financial status. It helps in matching revenues and expenses to the correct accounting period.

Q4: Are there different types of accrued interest?

• A4: Yes, there are two main types: Accrued Interest Payable (the interest a company owes but hasn’t paid) and Accrued Interest Receivable (the interest a company is owed but hasn’t received).

Related Terms with Definitions

• Coupon Rate: The annual interest rate paid on a bond, expressed as a percentage of the face value.
• Yield to Maturity (YTM): The total return anticipated on a bond if held until it matures, accounting for interest payments and principal repayment.
• Interest Income: The income earned from investments or savings accounts from periodic interest payments.
• Interest Expense: The cost incurred by an entity for borrowed funds.
• Bond: A fixed income instrument that represents a loan made by an investor to a borrower.
• Principal: The initial amount of the loan or the original amount of the investment.

Online Resources

1. Investopedia’s Accrued Interest Explanation
2. Revenue Guidance from Financial Accounting Standards Board (FASB)
3. U.S. Securities and Exchange Commission Information on Bonds
4. Khan Academy Financial Accounting Lectures

References

1. FASB ASC 310-10; Summary of Interest on Receivables
2. Financial Accounting standards IAS 39; Financial Instruments: Recognition and Measurement
3. Perez, Robert; “Investments; An Introduction to Accrued Interest,” McGraw-Hill Publications, 2019.

Suggested Books for Further Studies

1. “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
2. “Principles of Financial Accounting” by Stephen Hermanson et al.
3. “Finance and Accounting for Nonfinancial Managers” by William G. Droms and Jay O. Wright
4. “The Handbook of Fixed Income Securities” by Frank J. Fabozzi

Real Estate Basics: Accrued Interest Fundamentals Quiz