In order to understand the accounting for Interest Payable, we first need to understand what Interest Expense is. Interest expense is the cost of using monitory facilities or consuming financial benefits for some time.
When this Interest Expense has been created, in return for consuming the financial benefits, but not have been paid as at the date of the accounting report, this is known as Interest Payable (that means it has yet to be paid).
Interest Payable is an account on the Liability side that represents the measure of costs of interest the organization owes as at the date on which the statement of financial position is being prepared.
Interest Payable can be defined as the measure of interest costs on its obligation and capital rents that an organization owes to its lenders and suppliers at the date on which the statement of financial position is being prepared.
This total amount of interest payable can be a key component of the financial statement analysis because if the remaining interest to be paid is an unusually larger amount than the average, it shows that a business is defaulting on its obligation commitments.
Bookkeepers understand that if an organization has an amount outstanding in the account of Notes Payable, the organization ought to report some of that amount in Interest Expense and some in the Interest Payable account.
The explanation is that every day that the organization owes cash to some party, it is causing premium cost and a commitment to pay the premium of using that cash.
Except if the interest expense is paid in advance, the organization will always have to record interest payable in its statements of balance sheets to report the interest to be paid to the lender.
Interest payable can incorporate costs that have already been charged or the costs that are accrued, however, the accrued interest expenses may show up in a different Accrued Interest Liability account on the statement of financial position.
On account of capital rents, an organization may need to deduce the measure of payable interest expense, in view of a deconstruction of the fundamental capital rent.
The interest that an organization will cause later on from its utilization of existing obligation isn’t yet a cost, thus it isn’t recorded in the interest payable account until the period in which the organization brings about the cost.
Up until that time, the future obligation might be noted in the notes to the financial statements that are published in the annual reports.
The following example will explain Interest Payable more properly; a business owes $3,000,000 to a bank at a 5% financing cost and pays interest to the provider at each quarter.
Following one month, the organization is obligated to pay an interest cost of $5,0000, which will be debited to the Income Statement as Interest Expense and at the same time, it will be credited to the statement of financial position as Interest Payable.
The organization will do the same accounting entries for three months and then after the third month, when the Interest Payable account will be summed up to $150,000, the company will pay its quarterly interest payment and the Interest Payable account in the statement of financial position will be shifted to zero.