What Is an Accrued Interest?

Accrued interest, the unpaid interest earned on investments like bonds and CDs, is calculated by multiplying the annual rate by the principal and accrual period, and considering for its tax implications and payment schedules.

Oct 17, 2024 at 09:06 am

What is Accrued Interest?

1. Definition:

Accrued interest refers to the interest that has been earned but not yet received for an investment. It represents the accumulated but unpaid interest that increases over time until it is paid or credited to the investor's account.

2. Calculation:

Accrued interest is calculated by multiplying the annual interest rate by the principal amount of the investment and the time period over which it has accrued. The formula is:

Accrued Interest = Annual Interest Rate x Principal x Time

3. Time Period:

The time period used in the calculation can vary depending on the type of investment, such as:

• Bonds: Typically calculate accrued interest from the last interest payment date, which is usually semi-annually or annually.
• Certificates of Deposit (CDs): May calculate accrued interest daily or monthly.

4. Significance:

Accrued interest is important for investors to consider when valuing a fixed income investment. When purchasing a bond that is actively trading in the secondary market, the buyer will need to pay the accrued interest to the seller in addition to the bond's principal value.

5. Taxation:

In many countries, accrued interest is taxable as income. However, it is not officially recognized until it is received by the investor.

6. Payment:

Accrued interest is typically paid on a regular schedule, such as monthly, semi-annually, or annually. However, some investments may allow for the accrued interest to be added to the principal balance and compound over time.