What is Foolsaurus?

It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!


Accrued Interest Calculations for Accounting

Original post by Craig Woodman of Demand Media

Accruals refer to accounting rules governing how income and expenses are calculated in a financial statement. An accrued expense is an expense that has been incurred, but has not yet been paid. Accrued income is similar, except it is commonly labeled as an account receivable. Accountants and bookkeepers must figure the value of various accrued expenses, including interest, to allow for accurate financial reporting of income and expenses.

Notes or loans

A loan will accrue interest based on the time frame that has passed since the interest was last paid. For example, a loan can have a 12 percent per year interest rate, payable on the last day of each month. This yields a 1 percent interest rate per month, or 0.0334 percent per day, based on a 30-day month. If the loan balance is $1,000, the accrued interest as of the 15th of the month is $5.10, or 0.0334 percent times the balance of $1,000.

Bonds

Bonds are a corporate obligation to pay a debt, and accrued interest is calculated in much the same manner as a loan or promissory note. If someone purchases a bond on the secondary market, he pays the seller for the accrued interest. The seller multiplies the coupon rate of the bond by the fractional amount of the coupon period that has passed. If a bond pays $80 in coupon payments semiannually, and a person buyer the bond one quarter of the way into the coupon period, the buyer pays the seller $20 in accrued interest, or one-fourth of $80.

Saving's Accounts

Savings accounts also use accrued interest, with the total interest for an accounting period posting at the end of that period. Although the interest hasn't posted to the account, if the account were closed during the middle of the accounting period, the bank would add the accrued interest to the account proceeds, unless the account rules expressed differently. Saving's account accrued interest calculations are the same as loan calculations.

Compound Interest

Compound interest is the effect of interest earned during an accounting period on interest that has been paid during a prior accounting period. Interest is not earned on the accrued interest, as a rule, but is calculated based on the account balance as of the last interest posting date. If the account offers daily compounding, the accrued interest would be posted daily to allow this calculation.

                   

References

About the Author

Craig Woodman began writing professionally in 2007. Woodman's articles have been published in "Professional Distributor" magazine and in various online publications. He has written extensively on automotive issues, business, personal finance and recreational vehicles. Woodman is pursuing a Bachelor of Science in finance through online education.

Advertisement