When investing in stocks and bonds, investors are paid either an accrued interest vs regular interest at an agreed period. The interest payments are not paid immediately, and security issuers will owe investors some money at any particular time, depending on the time that has elapsed since the last payment was received.
Accrued interest refers to the accumulated interest charges that have been recognized in the books of accounts but have yet to be paid. Regular interest, on the other hand, can be the interest earned on bank savings or the interest charged for borrowing money from the bank.
Accrued interest is the accumulated interest that has been recognized and recorded but has not been paid as of a specific date.
Regular interest is the payment made in exchange for borrowing money from a lender.
An example of accrued interest is bond interest and loan interest, which are recognized before the actual payment is made.
What is Accrued Interest?
Accrued interest is an accounting term that refers to the amount of interest that has been incurred as of a specific date but has not yet been paid. Accrued interest can be two-sided, i.e., it can be in the form of accrued interest expense owed by the borrower or accrued interest income on customer deposits that are owed by the bank.
The term accrued interest can also be used to refer to accumulated interest on bond since the previous bond interest payment period. The amount of accrued interest is determined as of the last day of the current accounting period, which can be either a month, quarter, or year. It is recorded as an adjusting journal entry at the end of the accounting period.
The total accrued interest should be recognized and recorded in the income statement even before the payment is received. The amount of interest that has been recognized as an expense by the borrower but has not yet been paid to the lender is known as accrued interest payable, which is recorded in the income statement as an expense.
On the lender’s side, the amount of interest that has been recognized as revenue but has not yet been paid by the borrower is known as accrued interest receivable, which is recorded in the income statement as revenue. Also, the portion of interest revenue or interest expense that has not yet been paid is recorded as an asset or a liability in the balance sheet.
Accrued Interest Accounting
The accrual accounting concept requires that transactions should be recognized when they occur even if the payment has not been made. It ensures that the accumulated accrued interest is recognized and recorded in the right period when it occurs rather than when it is paid. It is contrary to the cash accounting concept, which requires that revenue and expense transactions be recorded when cash changes hands.
Practical Example of Accrued Interest
Assume that ABC Limited has taken a loan of $200,000 with XYZ Bank at an annual interest rate of 10%. ABC is required to make monthly interest payments based on the annual interest rate. The loan will mature within one year, and the principal and interest payments will be due in full at that time. During the loan period, ABC will owe the bank $54.79 every day in a 365-day year.
The interest expenses should be recognized and recorded on the company’s income statement as they build up, even though no cash has been remitted to the lender. At the end of the month, the company will have accumulated interest expenses amounting to $1,666.67, and it is the amount that it will pay as monthly interest payments.
The accumulated interest is referred to as accrued interest. Once the accumulated interest expenses have been paid, they will reset to zero, and the accrued interests will accumulate again month after month.
What is Regular Interest?
Regular interest is the payment made as charges for borrowing a loan. When a person borrows money from a bank, a credit union, or an individual, they are required to pay some interest on the loan extended to them. Interest can also be an income, where an individual earns interest income on money deposited in an interest-bearing account. It is explained in detail below.
Interest on Borrowed Money
When a borrower takes a loan from a bank or other financial institution, the lender charges an interest rate that is expected to be paid within the loan duration. The interest is the cost of borrowing, and the interest rate charged will depend on various factors such as the Federal Reserve lending rate, inflation, loan maturity period, credit score, and credit history.
For example, if a person takes a loan of $10,000 at an interest rate of 12%, he/she will be required to pay an interest of $1,200 for the loan. If the duration of the loan is one year, the borrower will be required to pay $100 per month in interest payments.
Interest Rate on Deposits
When you deposit money in an interest-bearing account, the bank pays interest at a specific percentage to use the money. Usually, banks use the money deposited in the customer’s account to make loans to borrowers. In return, the bank will pay some interest to the account holder, usually at a lower interest rate than the interest rate charged on loans.
Interest income on the deposits will continue to accumulate as long as the customer has money in the account and they continue depositing more funds into the account. Examples of interest-earning accounts include money market accounts, certificates of deposit, and savings account.
Thank you for reading CFI’s guide to Accrued Interest vs Regular Interest. CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)® certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful: