At the end of each accounting period, a business must record adjusting entries to acknowledge any interest it has accrued, or accumulated, over the period. The company may incur interest costs because it has borrowed cash from a lender or has issued debt, such as bonds, notes or commercial paper. The adjusting entries recognize the interest currently due to the lender.
The period-end procedure recognizing accrued interest is to debit the interest expense account and credit the interest payable account, which is a liability account. For example, suppose your company borrowed $100,000 on Oct. 1 at an annual interest rate of 5 percent, payable quarterly. The annual interest expense is $100,000 times 5 percent, or $5,000. Every quarter, you accrue interest of $1,250. Your end-of-period adjusting entry, dated Dec. 31, is to debit the interest expense account for $1,250 and credit the interest payable account for $1,250. You would repeat this procedure every quarter until you pay back the loan.
Relieving the Liability
You don't necessarily pay the lender when you enter the adjusting entry. For example, your arrangement might call for payment 15 days after the end of the quarter. In a process called relieving the liability, you would, in the example, wire $1,250 to the lender on Jan. 15. The accounting entry on Jan. 15 would be a debit to the interest payable account and a credit to the cash account, both for $1,250.