What is Interest Payable?
Interest Payable is a liability account, shown on a company’s balance sheet, which represents the amount of interest expense that has accrued to date but has not been paid as of the date on the balance sheet. In short, it represents the amount of interest currently owed to lenders.
For example, if interest of $1,000 on a note payable has been incurred but is not due to be paid until the next fiscal year, for the current year ended December 31, the company would record the following journal entry:
DR Interest Expense 1,000
CR Interest Payable 1,000
Interest payable amounts are usually current liabilities and may also be referred to as accrued interest. The interest accounts can be seen in multiple scenarios, such as for bond instruments, lease agreements between two parties, or any note payable liabilities.
Interest Payable in Bonds
Interest payable accounts are commonly seen in bond instruments because a company’s fiscal year end may not coincide with the payment dates. For example, XYZ Company issued 12% bonds on January 1, 2017 for $860,652 that have a maturity value of $800,000. The yield is 10%, the bond matures on January 1, 2022, and interest is paid on January 1 of each year.
On January 1, 2017:
DR Cash 860,653
CR Bond Payable 860,653
The issuance of the bond is recorded in the bonds payable account. The 860,653 value means that this is a premium bond and the premium will be amortized over its life.
On December 31, 2017:
DR Interest Expense 86,065
DR Bond Payable 9,935
CR Interest Payable 96,000
The interest expense is the bond payable account multiplied by the interest rate. The payable is a temporary account that will be used because payments are due on January 1 of each year. And finally, there is a decrease in the bond payable account that represents the amortization of the premium.
Therefore, on the balance sheet, the accounts would look like:
Bond Payable 850,718
Interest Payable 96,000
On January 1, 2018:
DR Interest Payable 96,000
CR Cash 96,000
Finally, the payable account is removed because cash is paid out. This payment represents the coupon payment that is part of the bond.
Interest payable accounts also play a role in note payable situations. For example, XYZ Company purchases a computer on January 1, 2016, paying $30,000 upfront in cash and with a $75,000 note due on January 1, 2019. The interest rate is 10% and is paid on January 1 of each year.
On January 1, 2016:
DR Equipment 86,459
CR Cash 30,000
CR Note Payable 56,349
The note payable is $56,349, which is equal to the present value of the $75,000 due on December 31, 2019. The present value can be calculated using MS Excel or a financial calculator.
On December 31, 2016:
DR Interest Expense 5,635
CR Interest Payable 5,635
The interest for 2016 has been incurred but is paid in the following year, on January 1, 2017, so it is recorded as a liability account in 2016.
On January 1, 2017:
DR Interest Payable 5,365
CR Cash 5,365
The account is then reduced to zero and paid out in cash.
This has been a guide to understanding how interest can move between the income statement and balance sheet. CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. Through financial modeling courses, training, and exercises, anyone in the world can become a great analyst.
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