Interest Payable
Represents the amount of interest currently owed to lenders
What is Interest Payable?
Interest payable is the amount of interest owed to lenders by a corporation as of the balance sheet date.
Suppose the amount is more significant than the average amount. In that case, it shows that a corporation is defaulting on its debt commitments, and this amount may be a critical aspect of financial statement analysis.
Billed and accrued interest can be included in interest payable. In contrast, accumulated interest may be recorded in a distinct "accrued interest obligation" account on the balance sheet if it is significant.
Whether the underlying debt is short-term or long-term, interest is deemed payable.
Short-term debt has a one-year payback period, whereas long-term debt has a more extended payback period. Because the interest that a firm will pay in the future as a result of interest payable use of existing debt is not yet a cost, it is not recorded in its account until the period in which the expense occurs.
Interest Payable in Bonds
Because a company's fiscal year-end may not match the payment dates, its accounts are typical in bond instruments.
For example, on January 1, 2017, FBK Company issued 12 percent bonds for $860,652 with a maturity value of $800,000. The bond has a 10% yield, matures on January 1, 2022, and pays interest on January 1 of each year.
1/Jan/2017:
| Dr. Cash | 860,653 |
| Cr. Bond Payable | 860,653 |
The bond's issue is tracked in the bonds payable account. The 860,653 value indicates that this is a premium bond, with the premium amortized throughout the bond's life.
31/Dec/2017:
| DR Interest Expense | 83,869 |
| DR Bond Payable | 12,131 (60,653/5yrs) |
| CR Interest Payable | 96,000 |
The interest expenditure is calculated by multiplying the payable bond account by the interest rate. Payments are due on January 1 of each year; thus, the payable account will be utilized temporarily.
The amortization of the premium is shown in a decrease in the bond payable account.
As a result, the accounts on the balance sheet would look like this:
| Bond Payable | 848,522 |
| Interest Payable | 96,000 |
1/Jan/2018:
| DR Interest Payable | 96,000 |
| CR Cash | 96,000 |
Finally, the payable account is deactivated because money has been disbursed. This payment represents the bond's coupon payment.
Note Payable
Note payable scenarios also play a role. For example, on January 1, 2016, FBK Company acquired a computer for $30,000 in cash and a $75,000 note due on January 1, 2019. The current rate of interest is 10%.
1/Jan/2016:
| DR Equipment | 86,459 |
| CR Cash | 30,000 |
| CR Note Payable | 56,349 |
The present value of the $75,000 due on December 31, 2019, is $56,349, which is the amount payable on the note. MS Excel or a financial calculator may compute the current value.
31/Dec/2016:
| DR Interest Expense | 5,635 |
| CR Note Payable | 5,635 |
The interest for 2016 has been accumulated and applied to the outstanding sum on the Note Payable.
31/Dec/2017:
| DR Interest Expense | 6,198 |
| CR Note Payable | 6,198 |
31/Dec/2018:
| DR Interest Expense | 6,812 |
| CR Note Payable | 6,812 |
1/Jan/2019:
| DR Note Payable | 75,000 |
| CR Cash | 75,000 |
The note payable account is depleted to zero, and cash is distributed.
How to calculate Interest Payable
When determining, follow these steps:
1. Make a list of your payable notes
To figure out how much interest you owe, first, figure out how much money you owe on your notes. The agreed-upon amount you expect to borrow is referred to as notes payable.
For example, if you want to start a new firm, you may borrow $15,000 from a buddy.
2. Using a decimal converter, convert your interest rate to a decimal
After that, figure out what your interest rate is. That would be the interest rate a lender charges when you borrow money from them. Convert your interest rate to a decimal after you have it.
For example, if your interest rate is 9%, it will be converted to 0.09 in decimal form. This allows you to use the rate later in your calculation.
3. Decide how long you want to calculate for
Decide how much time you'll need to compute your interest. Divide by 12 for calculations that look at it over months. For example, divide by four if your interest period is quarterly and by 365 if your interest period is daily.
For example, if you want to figure out how much interest you'll have to pay on your new company loan over the following five months, you'd pick 12 as your bottom number.
4. Determine your interest rate regularly.
Divide the interest rate by the time once you have the interest rate decimal and time. This computation determines your monthly interest rate.
So, in the case above, your fraction is 0.09 / 12. This gets you a 0.0075 percent annual interest rate.
5. Determine the amount of interest that must be paid.
Multiply your payable notes by your periodic interest rate to obtain it.
Using the same example, our interest payment would be $112.50 (0.0075 x $15,000) = $112.50 in the case above.
This implies you'll pay $112.50 monthly in interest on your friend's debt.
Example of Interest Payable
Few of the examples are:
Example 1
To help you understand how interest is calculated, consider the following example:
Higgins Woodwork Company borrowed $50,000 on January 4 to build a new industrial facility. The loan carries a 15 percent yearly interest rate.
When the payment is due on October 4, Higgins Woodwork Company forms an arrangement with their lender to reimburse the $50,000 plus a 10-month interest.
Higgins Woodwork Company owes $625 in interest as of February 4, or:
[($50,000) times (0.15 x 12 months)]
They have the following liabilities on their balance sheet:
- $50,000 in notes payable
- $625 in interest is due.
Higgins Woodwork Company owes $1,250 in interest by March 4th, or [($50,000) x (.15 x 12 months) x (2)]
Their current March balance sheet would look like this:
- $50,000 in notes payable
- $1,250 in interest is due.
Higgins Woodwork Company has an interest rate of $1,875 by the third month, April 4, or [($50,000) x (.15 x 12 months) x (3)]
The following would be on their April balance sheet:
- $50,000 in notes payable
- $1,875 in interest is due.
Example 2
Assume Rocky Gloves Co. borrowed $500,000 from a bank to expand its business on August 1, 2017.
The interest rate was 10% each year, and they had 20 days after each month's conclusion to pay the interest charge.
As of December 31, 2017, determine the company's interest expenditure and interest due.
Let's start by calculating the loan interest expense.
The monthly interest expense on the loan would be = ($500,000 * ten percent * one-twelfth) = $4,167.
Since the loan was obtained on August 1, 2017, the interest expenditure in the 2017 income statement would be for five months. However, if the loan had been accepted on January 1, the annual interest expense would have been 12 months.
The amount of interest expenditure on the income statement would be = ($4,167 * 5) = $20,835.
The amount of interest due would be calculated differently.
Since the interest for the month is paid 20 days after the month ends, the interest that is not settled would be only in November when the balance sheet is completed (not December).
Also, as previously said, the interest expenditure that must be paid after December 31 will not be counted.
As a result, the interest due is a mere $4,167.
Interest payable vs. interest expense
While both terms are concerned with a company's borrowing costs, they differ significantly. The following are some of the distinctions between interest payments and interest expenses:
1. Total vs. current interest
Interest expenditure is a line item on a company's revenue statement that shows the total interest it owes on loan. On the other hand, interest payment keeps track of how much money an organization owes in interest that it hasn't paid.
The amount owed in interest is calculated over a specific period.
For example, if the firm took out a loan three months ago, it would only record the amount it had spent in the last three months.
2. Outstanding expense vs. expense
A tremendous cost, or an amount due but not yet paid as of the balance sheet recording date, is interest payable. Interest expense is a typical expense that is required and paid regularly.
For example, a corporation may have paid $25,000 in interest during the previous year, yet the interest payable is only $2,083.33 ($25,000 / 12).
3. Liabilities side vs. debit side
On the liabilities side of the balance sheet, there is interest payable. Interest expenditure is recorded on the debit side of a company's balance sheet. This is because businesses credit interest owed and debit interest expenditure.
Example
Gigantic Ltd. has secured a $2 million loan from a bank. They must pay an annual interest rate of 12% on loan. Interest should be paid every quarter.
What are our thoughts on interest expense and payable?
Everything in the preceding example is comparable to what we've seen in earlier instances.
The only difference in this scenario is the time frame for paying the interest charge. It happens every three months here.
Let's start by calculating the annual interest expense.
For a year, the interest expense would be
=($2 million * 12%) = $240,000
We obtain
= ($240,000 / 12) = $20,000/month
if we compute the interest charge for each month.
When the firm accrues $20,000 in interest after the first month, the company will debit $20,000 as interest expenditure and credit the same amount to the payable balance sheet.
The firm would make the identical entry at the end of the second month, resulting in a balance of $40,000 in the interest payable account.
The corporation would make the identical entry at the end of each quarter, and the total in the payable account would be $60,000. (until the interest expenses are paid).
The payable account would be zero after the interest expenditures are paid, and the corporation would credit the cash account with the amount paid as interest expense.
Interest payable on the balance sheet
It is a liability account, and the sum shown on the balance sheet until the balance sheet date is usually depicted as a line item under current liabilities.
The unpaid interest expenditure for the current period, which contributes to its obligation, is stated in the income statement.
Because interest is a charge for borrowed funds (financial item), it is not recorded under the operating expenses part of the income statement. Instead, it's frequently included in the "non-operating or other items column," which comes after operating income.
To summarize the preceding concepts, consider the following example.
Example
Maria Textile Company requires $500,000 in cash right away. To fulfill this demand, it issues a 6-month 15% note due on November 1, 2020, and collects $500,000 in cash from the lender on the same day.
On April 30, 2021, Maria will return the principal amount of the loan plus interest at a rate of 15%, at which time the note payable will become due.
Required:
- Prepare to adjust entries at the end of November and December to account for interest expenditure.
- Calculate the total interest that will be due on December 31, 2020.
- In its balance statement as of I December 31, 2020, how would the Maria Textile Company reflect the original debt of $500,000 and the interest payable thereon?
- March 31, 2021?
Solution
Make the following adjustments to the entries to incur an interest charge at the end of November and December 2020:
For one month's interest, multiply $500,000 by 15% and divide by 12 to get $6,250.
| Date | Particulars | Debit | Credit |
|---|---|---|---|
| Nov.30 | Interest expense Interest payable | 6,250 | 6,250 |
| Dec.31 | Interest expense Interest payable | 6,250 | 6,250 |
The following is the total amount of interest due on December 31, 2020:
November interest + December interest = $6,250 + $6,250 = $12,500
Alternatively, the following formula may be used to calculate the interest due on December 31, 2020:
15 percent of $500,000 divided by 2/12 = $12,500
(i) On December 31, 2020
Charlie Company's current liabilities column of its balance sheet would show the note payable and interest thereon for two months as follows:
| Charlie Textile Company Balance sheet December 31, 2020 | |
|---|---|
|
Liabilities & Stockholders' Equity Current Liabilities Notes payable $500,000 |
|
The $12,500 in interest expense for 2020 must be charged to the income statement for that year.
The corporation has not yet incurred interest for the remaining four months (i.e., $25,000 = $500,000 15 percent 4/12). As a result, the balance statement generated on December 31, 2020, cannot be accumulated and recorded as a liability.
Only when the corporation uses the loan and incurs interest expense in the next month will the obligation exist. The corporation can, however, include the necessary information in the notes to its financial statements regarding this prospective obligation.
(ii) On March 31, 2021:
It will have a credit balance of $31,250 at the end of the first quarter of 2021 (i.e., on March 31, 2021), as calculated below:
15 percent of $500,000 divided by 5/12 = $31,250
Both notes and the interest are due and they will be reported on the balance sheet as follows on March 31, 2021:
| Charlie Textile Company Balance sheet December 31, 2020 | |
|---|---|
|
Liabilities & Stockholders' Equity Current Liabilities Notes payable $500,000 |
|
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