Accrued Interest

Accrued Interest refers to the interest that has accumulated on a loan or bond since the last payment was made but has not yet been paid. This interest is recognized in financial statements and can affect the value of investments.

For example, if a bond pays interest annually and the interest payment is due on December 31, but the bondholder sells the bond on June 30, the bondholder would be entitled to receive six months’ worth of accrued interest. If the bond has a Face Value of $1,000 and an annual Interest Rate of 5%, the accrued interest at the time of sale would be:

Accrued Interest = (Annual Interest Rate × Face Value) × (Months Accrued / Total Months)

In this case:

Accrued Interest = (0.05 × 1000) × (6 / 12) = $25

In cases of loans, if a borrower takes out a loan with monthly payments and makes no payment for three months, the accrued interest will be added to the total amount owed. This impacts the total interest the borrower will pay over the life of the loan.

In summary, accrued interest is an essential concept in finance that helps in accurately reflecting the interest earned or owed in financial statements and transaction records.