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What is Accrued Interest?

what is accrued interest

Accrued interest is the interest that has accumulated since the previous interest rate on security. The buyer typically pays the seller for the interest incurred, either as part of the purchase price or as a separate payment, if a security is sold between two payment periods.

Customer to Bank Executive: I want to redeem my FD. 

Bank: sure sir.

Customer: How much interest will I get?

Bank: 0%, since it has not matured yet. 

Deep Down: Accrued Interest

It provides a mechanism to track interest that has accumulated over time but hasn’t yet been paid. Whether or not the money has been received, transactions must be recorded as they happen under accrual accounting. This revenue recognition concept is maintained in your records by recording accrued interest on your income statement.

Imagine that a corporation borrows money to buy equipment for the business. This loan’s interest is paid on the first of every month. Before making its first interest payment in a given month, the business could employ this equipment to produce some money. In its present monthly records, the company would note the interest it anticipates paying on the first of the next month. Despite not yet receiving the money in person, the bank would nonetheless report this interest as income for the current month’s accounting period.

Formula of Accrued Interest

Using the accrued interest calculation below, you may determine how much interest should be recorded:

(Interest Rate x (Days / 365)) x Loan Value equals accrued interest.

With accounting periods based on the calendar month or year, this fundamental formula, which displays the interest rate as a percentage, performs well. You can change it as necessary to match the financial conditions or requirements of your company.

Now try to answer this numerical, 

Ram purchased a bond of worth Rs.10,000 by which he can have a 15% annual return. after 123 days he sold bonds to Shayam and then calculate the total amount which is to be paid from Shayam to Ram. 

Comment your answer.

Final Words

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The amount of interest generated on a loan, such as a bond, but not yet collected is known as accrued interest. 

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Rupay Rajat
Rupay Rajat

Rupay Rajat is a financial and investing blog. I write about financial instruments and the stock market in the most easiest language.