Definition of Accrued Interest
Accrued interest is the amount of loan interest that has already occurred, but has not yet been paid by the borrower and not yet received by the lender.
Under the accrual basis of accounting, the amount of accrued interest is to be recorded with accrual adjusting entries by the borrower and the lender before issuing their financial statements.
The borrower's adjusting entry will debit Interest Expense and credit Accrued Interest Payable (a current liability). The lender's adjusting entry will debit Accrued Interest Receivable (a current asset) and credit Interest Revenue (or Income).
Example of Accrued Interest
Let's assume that on December 16, a company borrows $20,000 from its bank at an annual interest rate of 6%. The first interest payment is due 30 days later on January 15. Both the company and the bank have accounting years which end on December 31.
The accrued interest as of December 31 is $50 ($20,000 X 6% = $1,200 per year = $100 per month = $50 for 1/2 month).
The company's adjusting entry will debit Interest Expense for $50, and will credit Accrued Interest Payable for $50.
The bank's adjusting entry will debit Accrued Interest Receivable for $50, and will credit Interest Revenue for $50.