Accrued Interest Journal Entry

Accrued interest is the interest that incurs due to a loan that creditor issues to the borrowers, but it is not yet paid or received by both parties. It can be an interest expense for the borrower. For the creditor, the accrued interest refers to the interest income.

When creditors issue loans to the borrower, it always attaches the interest rate in the credit term. The borrower needs to pay back principal plus interest based on this rate. The borrower will account for the interest amount as the expense in the income statement. It is also known as the finance cost.

Creditors expect to receive the principal plus interest. It is the main income for the creditor or bank which issue loan to individuals and companies.

The payment of loan will be made based on the loan repayment schedule which is started after the borrower receives a loan from the creditor. It will end based on the agreed term between both parties. The loan repayment schedule can be different from the accounting fiscal year. Both borrower and creditor need to prepare annual financial statements, so they need to take into account both revenue and expense. They need to calculate and record accrued interest even the cash flow is not yet made based on payment schedule.

This is the reason that needs to be prepared for accrued interest. Borrower needs to calculate accrued interest which will impact the expense and payable. On the other hand, the creditor needs to record accrued interest which impacts the interest income and receivable.

Accrued Interest Journal Entry

Borrower

Interest expense is the expense that borrowers need to record over the period of the loan term. It needs to divide equally to each month (if not day) within the loan period. However, the borrower makes payment based on the loan schedule which can be different from the accounting fiscal year.

At the end of the month, borrower needs to record interest portion which not yet been paid to the creditors. It will represent as interest expense on income statement and interest payable.

The journal entry is debiting interest expense and credit interest payable.

On the payment day, borrower needs to pay interest base on the schedule. They will record cash paid to the creditor and reverse interest payable and some portion of interest expense. The journal entry is debiting interest expense, interest payable and credit cash paid.

This transaction will reverse the interest payable to zero and record interest expense from the beginning of the new period to the payment date. Cash paid will equal the amount transferred to the creditor based on the schedule.

Creditor

Interest income is the revenue that creditor receives from borrower over the loan term. The creditors will receive interest income from borrower based on the loan schedule. Based on accounting, revenue will be recorded when it is earned rather than cash inflow. So how does the credit record interest income? Interest income is earned based on the loan period covered. So we need to allocate the interest income into the month which creditor earns.

At the end of the month, the credit needs to record interest income which not yet receive from the borrower. The double entry is debiting interest receivable and credit interest income.

On the payment schedule, borrower will make payment to the creditor. So creditor need to record revenue for the new month and reverse the interest receivable. The journal entry is debiting cash and credit interest income & interest receivable.

Accrued Interest Journal Entry Example

On 15 June 202X, ABC borrows $ 1 million from XYZ. Both party agrees to charge interest 12% per year. The borrower needs to pay monthly interest expenses based on the payment schedule below. The principal will be paid at the end of the 12^th month.

Please prepare the journal entry to relate to accrued interest. We will focus only on the interest, We will not discuss the journal entry of loan principal.

Borrower

ABC needs to make an interest payment on 15^th every month for a year. However, the accountant needs to prepare a monthly financial statement. So at the end of each month, they need to record both revenue and expense.

On 30 June, ABC did not yet make any interest payment to creditor yet, however there were some interest expenses already incurred. The company needs to record interest expense from 15^th– 30^th June which is the date from getting loan to the month-end.

Interest expense per month = $ 10,000

Interest expense 15 days = $ 5,000

On 30 June, ABC needs to record debit interest expense $ 5,000 and credit accrued interest payable $ 5,000.

Interest expense of $ 5,000 will be present on income statement. Accrued interest payable is the current liability that will be settled in the next payment.

On 15 July, it is the first time that ABC pays the interest to creditor. Based on the schedule, company needs to pay $ 10,000. However, this amount needs to settle the interest payable, and the remaining needs to record as expenses.

The journal entry is debiting interest expense, interest payable, and credit cash out.

Cash credit $ 10,000 represents the amount that ABC pay to creditor. The interest $ 10,000 covers from 15 June-15 July, however, the portion from 15-30 June is already recorded as an expense. So company need to record interest expense only $ 5,000, the remaining $ 5,000 is to settle the Accrued interest payable.

If we combine these two transactions, we can see that the cash out is $ 10,000 which agrees with the payment schedule. The interest expense is $ 10,000 ( $ 1,000,000 * 12%/12 months) which agree with the interest rate. The purpose of both transactions is to separate the interest expense to June & July which is based on the number of days the loan cover.

Creditor

XYZ is the creditor who will earn interest based on the loan provided to ABC. The interest will be calculated base on the principal ( $ 1 million) and 12% per year. However, the interest will receive once per month on the 15^th. Similar to borrowers, creditors are also required to prepare a monthly financial statement. All revenue and expense need to be fully recorded into the income statement.

On 30 June, XYZ does not receive interest payment from the borrower, however, they already making some interest income from the loan disbursement date (15 June) to the month-end. The same to borrower, XYZ makes an interest income of $ 5,000.

XYZ should make journal entry of debiting interest receivable $ 5,000 and credit accrued interest income.

On 15 July, borrower make an interest payment to XYZ. The borrower pays $ 10,000 base on the schedule. This amount covers the interest from 15 June to 15 July, but XYZ already record an interest income $ 5,000 in June. So they need to record interest income for the remaining balance.

The journal entry is debiting cash $ 10,000 and credit interest receivable $ 5,000 and interest income $ 5,000.

Cash increase of $ 10,000 represents the amount received from the borrower. Company record interest income $ 5,000 as the other half already record in June. The period covers both June and July, so the revenue needs to be separated too.

Both transactions record cash receives of $ 10,000. The interest income is $ 10,000 but it records in a separate month.

At the end of July both borrower and creditor need to accrue interest income and expense again.