Definition: The expense a company records under accrual accounting to recognize that the interest on money it has borrowed has built up but not yet been paid.
Example: BRW Corporation has borrowed $1 million from ML Bank. The loan calls for BRW to pay 6% interest on the loan at the end of each year that the money remains borrowed. BRW produces financial statements at the end of each quarter (ie: three months) of the year.
It would improper to ignore the interest on the loan that has been building up (ie: accruing) just because it won’t be paid until the end of the 4th quarter. The amount of interest that accrues each quarter is $1,000,000 * 6% * 1/4 year, or $15,000. The company should make an entry which debits Accrued Interest Expense for $15,000 and credits Accrued Interest Payable for $15,000.
Investeach explains: The matching principle of accounting calls for companies to “match up” revenues with the expenses that are incurred to generate those revenues. BRW is able to put $1 million to use, perhaps by purchasing manufacturing equipment, to generate sales throughout the year. It is only proper to match the loan interest that is building up throughout the year with those sales.
Riddle me this:
1. How do we compute the amount of accrued interest on a loan?
2. What do you suppose will happen to the balance in the Accrued Interest Expense account when the company writes a check to the bank to pay the accrued interest?
3. What can a company to do generate sales with money that it borrows?