Accrued interest is interest you earn, typically from a fixed-income investment such as a bond. Interest earned on fixed-income investments is referred to as accrued because it has been earned, but has not yet been paid out to investors. An interest expense is interest paid when people or companies take out a loan from a bank or other financial institution.
Fixed-income securities such as bonds have set schedules on which they make interest payments to investors. For example, bonds usually pay out interest once every six months. During the time between scheduled interest payout dates, the fixed-income security earns interest. This interest accrues until the day the interest payment is due to investors. The security issuer then makes an interest payment to its investors for all of the months the security earned and accrued interest.
Calculating Accrued Interest
To calculate accrued interest, the formula you use is: Interest rate x par value / (number of days / 360). The number of days is the time from the security’s issue to date to delivery date or settlement date. To illustrate this in example: The issue date on a municipal bond is January 1 and the delivery date is February 15. The interest rate on the bond is 5 percent and the par value of the issues is $1,000. To calculate the accrued interest: .05 x $1,000 x (104 / 360) = $14.50.
When you borrow money from a bank, one of the ways the bank earns money on the loan is by charging interest. When companies borrow money from banks or financial institutions, they too are charged interest on the loan. If a company issues bonds, the interest it pays to its bondholders is also an interest expense. Companies report the amount of money they pay in interest as their interest expense on the income statement.
Reporting Interest Expenses
Companies can report their interest expenses for loans or bonds separate from their income earned from corporate investments or accounts such as an interest-bearing savings account. In this case, the accounts are listed as separate line items on the income statement. Companies may also choose to combine their interest expense and interest income. In this case, they would subtract their interest expense from their interest income. The company would then report this amount as net interest expense or net interest income on the income statement.
- The U.S. Securities and Exchange Commission; Beginners Guide to Financial Statements; Income Statement
- New York University Stern School of Business; Yield to Maturity, Accrued Interest, Quoted Price, Invoice Price; September 1999
- Municipal Securities Rulemaking Board; Accrued Interest
- Forbes; Interest Expense; Scott Reeves; January 2006
Sue-Lynn Carty has over five years experience as both a freelance writer and editor, and her work has appeared on the websites Work.com and LoveToKnow. Carty holds a Bachelor of Arts degree in business administration, with an emphasis on financial management, from Davenport University.