What is Accrued Interest Definition and How to Calculate it?

Accrued interest represents the interest owed or earned since the last payment. It is the amount accumulated on an investment or loan that you are yet to receive or pay. Understanding the meaning of accrued interest is essential for investors and borrowers as it impacts the overall investment returns or the cost of borrowing.

The following sections will explore this interest type's definition, working, and calculation method.

What is Accrued Interest?

In terms of accounting, accrued interest is the interest amount incurred on a specific date but is yet to be received or paid. For investors, it is the interest they are yet to receive on an investment. For borrowers who get a Personal Loan or another credit product, it is the interest they still owe to the lender. Regarding bonds, it is the bond interest amount investors have accumulated since their last bond interest payment.

How Does Accrued Interest Work?

In an accrual-based accounting system, the payable or receivable interest amount is recorded in the account books irrespective of its payment or receipt date. Its primary purpose is to match the calculations and recognise revenue when accounting. The interest accumulates over time and is due for payment by the borrower or receipt by the investor.

Accrued interest works similarly to loans. For instance, if you borrow a loan with a 15% annual interest rate, the interest will keep accruing on the balance until you pay it off. With each EMI payment, a portion of the due payment goes towards its payment, and the rest reduces the principal loan balance.

Overall, accrued interest tracks the interest owed or earned over a period, even if it has yet to be paid or received. To understand the concept better, check the accrued interest formula below and learn how to calculate it.

Accrued Interest Formula

Do you want to learn how to calculate accrued interest? Here is the accrued interest formula for correct calculation:

Accrued interest = Principal amount x (rate of interest/365) x accrual period

How to Calculate Accrued Interest?

Divide the annual interest rate by 365 to calculate the daily rate of interest. Multiply the result by the number of days in the tenure to calculate the total accrual. For instance, if you borrow an instant loan of Rs 1 Lakh at an annual interest rate of 15%, here is how to calculate accrued interest:

Accrued interest = 1,00,000 x (0.15/365) x 30

= 1,00,000 x 0.00041 x 30

= Rs 1,233

You can easily calculate total interest for any accrual period using this accrued interest formula.

Read Also-What are compound interest and simple interest and how to calculate them?

Types of Accrued Interest

Accrued interest can be of two types, depending on whether you borrow, save, or invest money. Here’s an overview:

Accrued Interest When Borrowing

When you borrow a loan, interest is the cost of borrowing money. The lending institution adds the accrued interest to the principal amount. For credit cards, interest is calculated based on the APR (Annual Percentage Rate). The interest amount reduces as you pay your EMIs or credit card bills.

Accrued Interest When Saving or Investing

When you save or invest money, accrued interest is the interest you earn over time. Similar to borrowing, the interest accrued depends on the interest rate and the amount you save or invest. For example, when you purchase a bond, you basically lend a loan to a company or the government. At maturity, you receive interest based on your initial investment.

Read Also-Interest Rate: Definition, How It Works, Examples

Accrued Interest in Accounting

In accounting, accrued interest represents the income you have earned but have not received or expenses you are due to make but have not paid. Recording the interest accurately is important, as it reflects your actual financial position.

Accrued Interest Example in Accounting

If you borrow Rs 1 Lakh at an interest rate of 19% per annum on March 21, the first interest payment will be due on April 20 after 30 days. The annual interest is Rs 19,000 (1,00,000 x 19%), and the monthly interest payment will be Rs 1,583.33 (19,000 / 12).

If the accounting period ends on March 31, the interest incurred within March covers ten days. Therefore, the accrued interest will be Rs 528.89 (1,583.33 x 10/30) for the accounting period.

Accrued Interest in Bonds

In bonds, accrued interest accumulates if you do not trade the bond on the date of its coupon payment. It includes the interest earned from the last payment date up to the date of buying the bond. The accrued interest formula is as follows:

AI = t/T x PMT

Here, AI = Accrued interest

t = Number of days from the last date of payment to the settlement date

T = Number of days in the coupon payment period

PMT = Coupon payment of each period

Read Also- How is Interest Calculated on a Personal Loan

Accrued Interest Example in Bonds

Suppose you purchase a bond with a face value of Rs 10,000 at a coupon rate of 6% on January 1. If the bond pays interest semi-annually, on June 30 and December 31, and the company prepares financial statements quarterly, the calculation of interest earned during the first quarter (January 1 to March 31) would be as follows.

Since the bond pays interest semi-annually, the annual coupon payment is calculated as:

• Annual Coupon Payment = Rs 10,000 x 6% = Rs 600.

To find the interest earned in the first quarter (which is 3 months), determine how much interest is accrued during this period. Since the bond pays interest semi-annually (twice a year), calculate the interest for each semi-annual period:

• Semi-Annual Interest Payment = Rs 600 ÷ 2 = Rs 300 per semi-annual period.

For the first quarter (3 months), which is half of the first semi-annual period (6 months), the accrued interest would be:

• Accrued Interest for Q1= Rs 300 ÷ 2 = Rs 150.

Thus, the interest earned during the first quarter will be Rs 150.

Read Also- How is Interest Calculated

How Accrued Interest Impacts Your Personal Loan Repayment?

Now that you understand the meaning of accrued interest, it's important to know how it affects your Personal Loan repayment. Here’s how it works:

• Accrued interest increases your total loan cost.
• If you do not pay the interest on time, it will be added to your principal balance, resulting in higher interest costs over the loan tenure.
• Unpaid interest increases your EMI amount, making repayment more challenging to manage.

Conclusion

Accrued interest is the interest you earn on savings and investments and pay on loans. Use the accrued interest formula to calculate your interest and plan your finances more effectively. When you borrow an instant loan from Hero FinCorp, ensure timely EMI payments to avoid increasing your interest costs.

Frequently Asked Questions

How does accrued interest affect bonds?

Accrued interest in bonds occurs if you do not trade them on their coupon payment date. It represents the interest earned from the last coupon payment date up to the date of purchase.

What is the impact of accrued interest on taxes?

Accrued interest on investments increases your taxable income. Conversely, paying accrued interest on a loan may make you eligible for a larger tax deduction.

Why is accrued interest important for investors?

Accrued interest is important because it represents the interest earned on investments over time, contributing to higher overall returns.

What is the difference between accrued interest and regular interest?

Regular interest refers to immediate payments received or paid, while accrued interest accumulates over time but has not yet been received or paid.

Is accrued interest a debt?

Accrued interest can be considered a debt when it is the interest you owe to the lender for a loan you have borrowed.