Quick Answer
Accrued interest is interest that has been earned or incurred but has not yet been received or paid. Under accrual accounting, record the amount in the period it relates to: debit Interest Expense and credit Interest Payable when a business owes interest, or debit Interest Receivable and credit Interest Income when it has earned interest. Reverse or settle the accrual when cash is paid or collected.
What Is Accrued Interest?
Interest usually accumulates day by day, while lenders and borrowers often exchange cash monthly, quarterly, or at maturity. The gap between the earning or incurring of interest and the cash transaction creates an accrual. Accruing interest prevents financial statements from understating expenses, liabilities, revenue, or assets at period-end.
For example, if a company has a loan outstanding on December 31 and the lender will not debit the bank account until January 15, the company still owes interest for the days in December. The December financial statements should include that December interest even though no cash has moved. The same principle applies to a note receivable on which interest has been earned but not collected.
Journal Entry for Interest Accrued on a Loan
Assume a company calculates $1,200 of interest incurred during December. The payment will be made in January.
December 31 — Accrue interest expense
Dr. Interest Expense ............... $1,200
Cr. Interest Payable ................ $1,200
The debit recognizes the cost in December. The credit records a current liability because the company has an obligation to the lender. This entry does not reduce the loan principal. The principal remains in the loan account until a separate repayment is made. For related borrowing entries, see our guide to journal entries for interest expense.
Journal Entry When Accrued Interest Is Paid
When the company pays the $1,200 in January, it removes the payable rather than recording January expense again.
January 15 — Pay previously accrued interest
Dr. Interest Payable ............... $1,200
Cr. Cash ................................. $1,200
Recording Interest Expense again in January would double-count the cost. If the January payment also includes new January interest, split the entry between the opening payable and current-period expense. When a payment includes principal, use the loan amortization schedule to record principal separately; the accounting treatment for that transaction is explained in journal entries for loan payments.
Journal Entry for Interest Earned but Not Collected
A lender or investor may earn interest before receiving cash. Suppose a company holds a $50,000 note receivable and has earned $500 of interest by month-end.
Month-end — Accrue interest income
Dr. Interest Receivable ............. $500
Cr. Interest Income .................. $500
Interest Receivable is an asset representing the contractual amount due from the borrower. Interest Income belongs in the period earned. When the borrower later pays, debit Cash and credit Interest Receivable. If the cash receipt includes both principal and interest, credit the note receivable for principal and the interest receivable for the accrued interest.
How to Calculate Accrued Interest
A simple calculation is:
Accrued Interest = Principal × Annual Interest Rate × Days Accrued ÷ Days in Year
Suppose principal is $100,000, the annual rate is 7.2%, and 20 days have elapsed in a 365-day year:
$100,000 × 7.2% × 20 ÷ 365 = $394.52
Use the contract's day-count convention when it differs from a 365-day basis. Bonds and other instruments may use 360 days, actual/actual, or another convention. Confirm whether the rate is fixed, variable, simple, or compounded, and document the calculation so another reviewer can reproduce it.
Accrued Interest on Notes Payable
Notes payable commonly require a period-end accrual. Review the signed note, payment schedule, stated rate, and any fees treated as interest. Reconcile the calculated payable to the lender statement and investigate differences. A note payable accrual should agree with the liability roll-forward and the next payment's interest component. See journal entries for notes payable for the broader issuance and repayment entries.
Reversing Entries and Month-End Controls
Many companies reverse accrued interest on the first day of the next period. The reversing entry for the $1,200 example is a debit to Interest Payable and a credit to Interest Expense. When the invoice or payment is posted in January, the normal January entry then records the full amount without leaving duplicate expense. Reversals are optional, so the accounting policy must be consistent and clearly documented.
At each close, maintain an accrual schedule showing instrument, principal, rate, dates, day-count basis, calculation, preparer, reviewer, and settlement date. Tie the schedule to the general ledger, compare it with lender or borrower statements, and follow up on aged receivables. These controls reduce cutoff errors and make the balance sheet easier to audit. For a broader period-end checklist, review journal entries for accrued expenses.
Common Errors to Avoid
- Recording cash timing instead of the period in which interest accrues.
- Charging the same interest to expense both at accrual and payment.
- Failing to separate principal from interest in a combined payment.
- Using the wrong day-count convention or rate from the loan agreement.
- Leaving old accruals unreconciled after settlement.
Bottom Line
Accrued-interest entries align the income statement and balance sheet with the economics of a loan or investment. Record expense with Interest Payable when the business owes interest, and record income with Interest Receivable when interest has been earned. Reconcile the schedule, use the contract's calculation rules, and remove the accrual when cash is settled.
