Definition
The term accrued interest refers to the funds that are payable but not yet received because of a timing difference of cash flows. Accrued interest is oftentimes use in the context of a bond or another type of fixed income security.
Calculation
Accrued Interest = Fraction of Year x Principal x Rate of Interest
Where:
Fraction of Year is equal to the number of days in the period divided by the number of days in a year.
Principal is the remaining balance on the fixed income security or bond.
Rate of Interest is an annualized interest rate payable on the bond or security.
Explanation
Bonds make interest payments to bondholders at fixed intervals throughout the year, but the ownership of the bond can be transferred to another party at any time. The concept of accrued interest allows holders of fixed income securities, such as bonds, to be made whole for funds that are payable but not yet received if they decide to sell the security. Only the holder of the bond is eligible to receive the coupon payment. This means the market value of a bond is not just a function of interest rates and time to maturity, but also the value of the accrued interest.
Accrued interest can also refer to the interest earned on an outstanding receivable but not yet paid. For example, a company may sell goods to a customer and charge a rate of interest equal to 1% of the outstanding balance on the account if payment is not received in 30 days.
Example
Ann is thinking about selling $10,000 of Company A's bonds with a coupon rate of 5.000%. She knows the market value of the bonds, but would like to understand how much of that value is a function of the bond's accrued interest. The bond makes coupon payments quarterly, and it has been 63 days since the last payment. The calculation of accrued interest would be:
= (63 days / 365 days) x $10,000 x 5.000% = 0.1726 x $10,000 x 0.005, or $86.30
Related Terms
The cash basis accounting method calls for the recording of economic business events as cash is received or paid. Therefore, the cash method of accounting requires the reporting of revenues when cash is received from customers and payments are made for expenses.
Moneyzine EditorJanuary 10th, 2024
The matching principle is a financial accounting term that refers to a standard, which states that revenues generated in an accounting period need to be matched with the expenses incurred in that same accounting period.Moneyzine EditorFebruary 8th, 2024
Also referred to as "receivables," this is the accounting term used to describe claims the company has against others for goods, services, or money. Accounts receivable are usually non-written promises to pay for goods or services received but not yet paid for by a customer.Moneyzine EditorJanuary 3rd, 2024
Also referred to as "payables," this is the accounting term used to describe balances owed to trade partners for materials, supplies, goods and services that were purchased on credit. Accounts payable recognizes the timing difference between the company's receipt of the benefit or asset, and the payment for this expense.Moneyzine EditorDecember 12th, 2023
The financial accounting term accrued expense refers to costs incurred during an accounting period, but not yet paid for in cash by a company in that same accounting period.Moneyzine EditorJanuary 3rd, 2024
The financial accounting term accrued revenue refers to income earned during an accounting period, but not yet recorded or received prior to the company's financial closing date.Moneyzine EditorJanuary 3rd, 2024
The term accrued market discount refers to the increase in the value of a bond as it approaches the day it is redeemable at par. The calculation of a bond's accrued market discount is not affected by falling interest rates.Moneyzine EditorJanuary 3rd, 2024
