How to Calculate Accrued Interest Expense

Buy strength and sell weakness

Computing accrued interest expense for fixed-income securities is straightforward, but investors must know what interest accrual system is being used. Corporate and municipal bonds use one system. United States Treasuries use another actual day count system. Variable-rate bonds use an accrual system like that used by the United States Treasuries. Whenever the variable interest rate changes, so must the new rate be recomputed for the new time period.

Things You'll Need

• Spreadsheet program

Instructions

1. Know that accrued interest expense is the amount of interest earned but not yet paid. Interest is only paid on the prescribed interest rate date (almost always a semiannual date for bonds). When bonds are traded during the semiannual period, the buyer pays the accrued interest and is repaid the accrued interest when the semiannual coupon is redeemed.

2. Accumulate information on the bond, including the date of the last coupon, the coupon rate, the maturity and the dates of the semiannual coupon payment. All this information should be on your purchase confirmation. If not, find the CUSIP number, a unique identifying number similar to a bar code, and identify the bond to your broker, who can then research all these details.

3. Calculate bonds issued by the United States government using the exact number of days in each month (excluding February 29 in a leap year). This is called "actual/365." Corporate bonds and municipal bonds assume 12 months of 30 days each. This is called "30/360."

4. Use column 1 of your spreadsheet calculator to input the par amount (the maturity value) of the bonds purchased. In column 2, input the interest rate of the bond. In column 3, multiply columns 1 and 2 to derive the annual amount of interest. In column 4, divide column 3 by column 2 to compute the amount of semiannual interest.

5. Count the number of days expired since the last coupon date. Enter the result in column 5. In column 6, enter the number of days in the semiannual period. For variable rate and United States Treasuries, this will be the actual number of days. For municipal and corporate bonds, the input will always be 180. Divide column 5 by column 6 and input the percentage in column 7. Multiply column 7 by column 4. The result is the accrued interest expensed by the government and accrued by the investor to date.

6. Understand that accrued interest expense for private transactions can be computed as the parties agree. The steps above detail the important issue--namely, that accrued interest expense must be accounted for in a systematic way involving the counting of specific days (the case with short-term notes) or by averaging days per month of the year.

7. Note that accrued interest expense for tax and accounting purposes is not usually deductible. Only interest paid or received should be deducted. There is some variation allowed depending on industry, but since no funds have changed hands until an expense is actually paid, the tax and accounting issue is rather straightforward.

Tips & Warnings

• Use convenient, readily available free online calculators to compute interest (see Resources).

Resources

• FINRA Website
• Accrued Interest Calculator