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The borrower accrues interest expense each period. It gets paid off at note's maturity.
Accrual-basis accounting means we must record interest expense at the end of each period it accrues (before maturity).
Scenario: On May 1st, 2022, you borrow a $1,000, 12% annual interest note due in 9 months from your local bank. Write the journal entry for December 31st, 2022.
The blue underlined text signals...
- We're writing the journal entry for December 31st, 2022, and the note was issued to us on May 1st, 2022 ➡️ We're recording Interest Expense over the course of 2022 (before we move into 2023).
- We will be paying this interest at maturity... ➡️ We will owe it back to the bank as Interest Payable.
Note Amount = $1,000
Annual Interest = 12%
Annual Interest = $1,000 x 12%
Annual Interest = $120
Monthly Interest = $120 / 12 months
Monthly Interest = $10
Between May 1st, 2022 and December 31st, 2022, there's 8 months.
2022 Interest = $10 x 8 months
2022 Interest = $80
The reason is...
- We have incurred an expense (+) in the form of interest over the course of 2022.
- This is represented through Interest Expense.
- Which is an expense account, and therefore has a normal debit balance.
- So, to increase it by $80, we'll debit it.
The reason is...
- We now owe (+) this interest once the note matures in 2023, and we're liable to pay it.
- This is represented through Interest Payable.
- Which is a liability account, and therefore has a normal credit balance.
- So, to increase it by $80, we'll credit it.
