Loans are an integral part of business growth and capital management. But loans almost always come with interest, and that interest needs to be treated specially from an accounting perspective.
In this guide, we’ll explore the concept of accrued interest, outlining what it is, how it works, and how to calculate accrued interest correctly.
What is accrued interest?
Accrued interest is the interest that builds up on a loan or investment over time but hasn’t been paid or received yet. It grows daily, even if payments occur less often, and is a key concept in accrual accounting.
Here’s the problem from an accounting standpoint:
You pay interest at regular intervals, such as monthly or quarterly, but your loan accrues interest gradually, often daily. That means that interest builds up between payment dates, and accrued interest is used to represent the cost of borrowing that money over time.
Accrued interest ensures that interest expenses and revenues are recognized in the correct accounting period, even if the actual cash hasn’t been paid. This treatment aligns financial records with the accrual basis of accounting.
Accrued interest is recorded as a liability by the borrower and as an asset by the lender.
How accrued interest works
Accrued interest works a little differently depending on the context in question.
Accrued interest in loans
In the context of a loan or line of credit, interest starts to accumulate daily based on he outstanding principal and the interest rate agreed upon with the lender.
This daily accumulation is recorded as accrued interest until the next scheduled payment is made,
For instance, if your business owes $100,000 at an annual interest of 6%, you’ll accrue $16.44 of interest each day. After 15 days, you’ll have accrued $246.58 of interest, though payment might not be due for another 15 days.
Accrued interest in savings and investments
If your business has cash in a savings account or an interest-bearing investment vehicle like a bond or term deposit, it earns interest daily.
Even though you might receive an interest payment monthly, quarterly, or even at maturity, you’re still accruing interest daily, and this is considered income, meaning it should be recorded as a receivable until it is paid.
Simply vs. compound interest
In either context, accrued interest can follow either a simple or compound interest model. Understanding the difference is important for accurately calculating and reporting accrued interest on financial obligations and investments.
Here’s how the two work:
- Simple interest is calculated only on the principal. For example, $10,000 at 5% simple annual interest earns $500 per year, regardless of how long it’s held.
- Compound interest builds on both the principal and the previously accrued interest. Over time, this results in faster growth for both interest expenses and income.
Why is accrued interest important to business?
The purpose of accrued interest is to help businesses accurately reflect their financial obligations and income (if you’re the lender) in their accounting records, ensuring expenses and revenue are recorded in the correct reporting period.
For borrowers, tracking accrued interest helps give a clearer picture of outstanding liabilities, which improves budgeting and cash flow planning. For lenders and investors, it ensures that interest income is recognized as it's earned, even if payment hasn’t yet been received.
How to calculate accrued interest
Accrued interest is calculated based on the principal, your annual interest rate, the number of days interest has accrued, and the day count basis (usually 365 days).
Here’s the formula accountants use to calculate accrued interest:
Accrued interest example
Let’s use a fictional example to illustrate that formula in practice.
Say your business takes out a $50,000 loan at an annual interest rate of 6%:
Accrued Interest = 50,000 × 0.06 × (15 / 365) = $123.29
Here, you would record $123.29 as an accrued interest expense, even though no cash has yet changed hands.
How to record an accrued interest journal entry
Accrued interest is recorded at the end of an accounting period to reflect expenses or income that have been incurred but not yet paid or received.
Naturally, the journal entries look different depending on whether you’re the borrower or the lender.
For borrowers (accrued interest expense)
Borrowers record accrued interest as an expense and a liability. This ensures the cost of borrowing is reflected in the correct period.
The journal entries are:
- Debit: Interest expense
- Credit: Accrued interest payable
This journal entry increases expense on the company’s income statement and adds a liability to the balance sheet.
For lenders (accrued interest income)
For lenders and investors, accrued interest is recorded as income and as a receivable. This reflects earned interest that has not yet been received.
The journal entries are:
- Debit: Accrued interest receivable
- Credit: Interest income
This entry records income on the income statement and adds an asset to the balance sheet until the interest is collected.
Impact of accrued interest on financial products
Accrued interest has various effects on financial health, and the exact impact depends on the financial product in question.
Loans and mortgages
Accrued interest increases the total interest expense recorded over time. It impacts both the borrower’s liability and financial reporting, as interest accrues daily but is typically paid monthly.
Credit cards
Credit card interest accrues daily based on the outstanding balance and the card’s annual percentage rate. But businesses don’t pay their cards off daily or even before the due date, meaning they may begin accruing interest immediately.
This can lead to rapidly growing liabilities if balances are not managed tightly.
Investments and savings
On the asset side, investments such as bonds, term deposits, and interest-bearing savings accounts generate accrued interest as income, not an expense.
For example, if a business owns a bond that pays interest twice a year, it will accrue daily between payment dates. This accrued interest boosts the investment’s book value and may be considered when selling the asset before maturity.
Strategies for managing accrued interest
Accrued interest can impact both cash flow and financial clarity if not carefully managed.
These strategies can help your business stay on top of obligations and reduce unnecessary interest costs:
- Pay weekly or biweekly instead of monthly to reduce the interest that accrues between payments, especially if it's compounding interest
- Pay down your principal early, reducing it to lower overall interest charges
- When interest rates drop or your credit improves, refinance to a lower rate
- Monitor accrued interest closely to improve the
- forecast and ensure you make timely payments that reduce your exposure to penalties
- Avoid skipping or postponing payments, as these increase the total cost of borrowing
How to effectively manage accrued interest on credit cards
Managing credit card interest requires a different approach to loan interest management.
These strategies help business reduce their overall exposure to interest on business cards:
- Pay the full balance by the due date to avoid interest charges entirely (if your card offers an interest-free grace period)
- Avoid carrying a balance if your card has a high APR or doesn’t offer a grace period
- Use a low-interest card for larger purchases where you plan to carry a balance
- Set payment reminders or automatic payments to minimize accrued interest and protect your credit score
- Monitor credit card statements regularly to catch unexpected charges, especially on variable-rate cards
Manage accrued interest with BILL
Whenever dealing with loans, credit cards, and other financial instruments that provide up-front funding, accrued interest is part of the picture.
The smartest finance leaders minimize their exposure to interest through a combination of effective strategies and powerful financial operations management software like BILL.
With BILL, you can:
- Automate outgoing payments
- Sync expenses with your accounting platform
- Design reporting dashboards that help you keep on top of interest
Frequently asked questions
What is computing accrued interest?
Computing is just another word for calculating. Computing accrued interest means calculating the amount of interest that has accumulated on a loan or investment within a specific period.
It typically involves applying the annual interest rate to the principal and prorating it over the number of days accrued.
Is accrued interest a good thing?
This depends on the context.
For lenders or investors, accrued interest is income earned—a good thing.
For borrowers, it reflects a growing liability—not such a good thing, though an integral part of debt financing.
What is the difference between accrued interest and regular interest?
Accrued interest is not a different kind of interest. It is simply the interest that builds up over time and is recorded before payment occurs.
It's an accounting concept used to match revenues and expenses to the correct reporting period.
Who benefits from accrued interest?
Lenders, investors, and financial institutions benefit from accrued interest as it represents an income stream for them.
How does accrued interest appear on financial statements?
This depends on what role your business plays in the loan:
- For borrowers, accrued interest appears as an interest expense on the income statement and as accrued interest payable on the balance sheet.
- For lenders, accrued interest appears as interest income on the income statement and accrued interest receivable on the balance sheet.
Is accrued interest taxable income or a deductible expense?
Both.
Accrued interest income is generally taxable, even if not yet received, and accrued interest expense is typically tax-deductible, even if not yet paid.
Do interest-free loans require accrued interest journal entries?
Generally speaking, no.
Since there’s no interest being charged or earned, there’s nothing to accrue. However, depending on the arrangement, accounting for imputed interest or fair value may still be required under certain financial reporting standards.
