You are currently viewing a sample of the Cram Kit. Click here to unlock everything.
The borrower accrues interest expense each period that will be 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.
We created the note on May 1st, 2022, and we're writing the journal entry for December 31st, 2022. Therefore, we're recording 2022 interest accrued (before 2023).
Annual Interest = $1,000 x 12%
Annual Interest = $120
But we need monthly interest...
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
Debit to Interest Expense because our note accrued $80 in interest expenses over 2022, and expenses (Interest Expense) have a normal debit balance.
Credit to Interest Payable because we owe this $80 to our local bank once the note matures, and liabilities (Interest Payable) have a normal credit balance.
The reason we're filing this Interest Expense under Interest Payable (instead of Cash) is because we owe all the interest on this note at maturity!
