What Type Of Account Is Interest Payable?

Interest payable refers to a line item in a company’s balance sheet that captures the amount of interest that has not been paid on the bonds, notes Accounts Payable loans or any other liability where interest is calculated. Interests payable is another topic that is important to capture from an accounting perspective.

What is Interest Payable?

Interest payable is typically recorded as accruals under the balance sheet. In simple terms, this is the interest that has been incurred and was not settled as of the date of the balance sheet. For example, if a company has a loan of $1 million at a 6% annual interest rate on a year-end basis, then in every quarter before the year-end, the company incurs an interest expense on its income statement. However, since the interest is only due when the financial statements are prepared at year-end, it has to be recorded in the interest payable account on the balance sheet as a future liability.

Key Characteristics:

- This is a key account that states the obligation for interest that has been accumulated.
- Shows the amount of interest expense on debts to be paid over a period that has not been paid
- It continues to increase because of unpaid interest expenses which build up in each period.
- Nevertheless, it falls under the Current Liability sub-section on the Balance Sheet.

Accounting Treatment:

Interest payable accounting has the following key steps:

- Interest Expense is determined and put in the Income Statement based on the credit terms.
- Another debit entry is posted to the Interest Payable account on the Balance Sheet
- When interest accrues, interest Accounts Receivable and Interest payable accounts are debited and the Interest payable account is credited when interest is paid.

This system helps in the right matching of the interest expenses to the correct accounting period as it accrues though the actual cash paid may occur later.

Associated Accounts:

Key accounts associated with Interest Payable:

- Interest Expense - Displays the costs of borrowed funds incurred over a period on the Income Statement.
- Loans/Notes/Bonds Payable – The liability accounts that capture the principal amount balances.
- Interest Income – If the company also has notes receivable, then the interest that would be earned on the note is as follows:

Importance of Interest Payable:

Some key reasons why properly accounting for Interest Payable is so important:

1. Facilitates Accrual Basis Accounting – This principle results in accrual basis accounting as it requires measurement of income and liabilities in an accurate and timely manner.

2. Accurate for Trade Credit Sales – Ensures that obligations are recorded as they occur, not when the payment is made, thus making financial statements more reliable. Offers a more accurate estimate of the company’s potential future cash needs.

3. Enables ratio analysis - Interest expense and payable amounts are components of ratio analysis that include, debt service coverage, times interest earned, and debt ratios among others making it easier to analyze.

Concisely, this has been a brief elaboration of how these people classify the interest payable under the accrued liabilities and why having well-defined processes of recognizing and making it is important for sound financial reporting, planning, and decision-making. It requires the use of basic accounting principles and approaches when recognizing the interest expense and liabilities.