Accrued Interest

Accrued interest is interest that has been earned by a lender or incurred by a borrower since the last payment date but has not yet been paid. The lender generally records interest income and a receivable, while the borrower records interest expense and a payable, subject to the instrument’s accounting requirements.

In bond trading, accrued interest also helps allocate the next coupon between seller and buyer when a bond settles between coupon dates. It is normally considered separately from the quoted clean price.

Key Takeaways

• Accrued interest grows with time between contractual payment dates.
• The same passage of time can create an asset for the lender and a liability for the borrower.
• Bond calculations must use the instrument’s coupon terms and day-count convention, not an automatic 365-day denominator.
• A bond’s dirty price generally equals its clean price plus accrued interest.
• Defaulted, zero-coupon, floating-rate, inflation-linked, and ex-coupon instruments can require different treatment.

Borrower and Lender Accounting

Suppose a borrower has incurred $4,800 of interest by month-end, but the next contractual payment is due the following month.

The borrower records:

1Dr Interest expense              $4,800
2  Cr Accrued interest payable            $4,800

Subject to its own recognition and measurement requirements, the lender may record the corresponding accrual as:

1Dr Accrued interest receivable   $4,800
2  Cr Interest income                     $4,800

When cash is paid, each party clears the payable or receivable. The two entities’ reported amounts may not always mirror each other because of credit impairment, transaction costs, effective-interest calculations, foreign exchange, timing, or different accounting policies.

Basic Accrued-Interest Formula

For a simple fixed-rate instrument, an illustrative calculation is:

The day-count fraction depends on the contract and market convention. Common conventions include actual/actual, actual/365, actual/360, and 30/360. The numerator, denominator, treatment of settlement dates, and coupon-period boundaries can all affect the result.

Worked Example: Loan Accrual

A $600,000 loan bears a fixed 6% annual rate. At the reporting date, 20 days of interest have accrued under an actual/365 convention.

The borrower records approximately $1,972.60 of interest expense and accrued interest payable. If the loan used actual/360 or a different contractual basis, the amount would differ.

This simple formula may not equal financial-statement interest expense for every instrument. The effective interest method can incorporate fees, premiums, discounts, and other contractual cash flows.

Worked Example: Bond Clean and Dirty Price

Consider a bond with:

• $100,000 par value;
• a 5% annual coupon paid semiannually;
• a $2,500 coupon payment each half-year;
• 60 accrued days in a 180-day coupon period; and
• a quoted clean price of $98,200 for the position.

The illustrative accrued interest is:

The dirty price, before transaction-specific costs, is:

The buyer pays the seller for the interest accumulated during the seller’s holding period, then ordinarily receives the full next coupon from the issuer. This settlement adjustment does not mean the buyer earned the full coupon economically.

Accrued Interest in Different Contexts

Accrued interest is not the same as a bond premium, discount, capital gain, or yield. It is a time-apportionment amount. Market value can move for interest-rate, credit, liquidity, option, and other reasons even while accrued interest increases.

Clean Price vs. Dirty Price

Conventions vary by market. Some securities trade flat without accrued interest, particularly in certain default or distressed situations. Ex-coupon rules can also change who receives the next coupon and how settlement is calculated.

How to Evaluate an Accrued-Interest Amount

1. Confirm the principal or par amount subject to interest.
2. Read the contractual coupon or effective-rate terms.
3. Identify the last payment, reporting, trade, and settlement dates.
4. Apply the correct day-count and business-day conventions.
5. Separate contractual accrued interest from premium or discount amortization.
6. Check whether the instrument is current, impaired, in default, floating-rate, or ex-coupon.
7. Reconcile the accrual to the next cash payment and investigate differences.

For variable-rate debt, verify the reset date, reference rate, spread, floors, caps, and lookback or observation conventions. A spreadsheet that uses the current rate for the entire period can produce a wrong accrual after a rate reset.

Common Mistakes and Limitations

• Describing accrued interest only as income and ignoring the borrower’s expense and liability.
• Using 365 days when the contract specifies actual/360, 30/360, or another convention.
• Calculating from trade date when the market convention uses settlement date.
• Treating accrued interest as part of the quoted clean price.
• Assuming the next coupon is all investment return; the purchase price may include compensation to the seller.
• Continuing normal accruals on a defaulted or credit-impaired instrument without checking the applicable rules.
• Giving tax conclusions from book accounting. Tax timing and original-issue-discount rules can differ by jurisdiction and instrument.

Accrued-interest calculations depend on contractual and market conventions. This page is educational and is not accounting, tax, legal, credit, or investment advice.

FAQs

Authoritative Sources

• FINRA: Bonds and accrued interest in secondary-market sales
• FINRA: Accrued Interest Calculator and day-count conventions
• IFRS Foundation: IFRS 9 Financial Instruments

Related Terms

• Accrued Expense
• Interest Expense
• Interest Income
• Debt
• Accounts Payable