Definition:
Interest expenses that are recorded in the income statement referred to costs charged to the entity by the bank, creditor and other lenders as the result of fund borrowing for periods of time. Those borrowing included bonds, loan, convertible debt, and credit charged.
Interest expenses are partially tax-deductible and the amount charged is based on the agreed rate. In the income statement, it is recorded separately from operation if the income statement uses a multiple-step income statement.
But if it uses a single-step income statement, it is recorded in the expenses section. Interest expenses are normally due for payment within a period of fewer than 12 months and the remaining balance is recorded under the current liability in the balance sheet.
Explanation:
The interest expenses here are neither the expenses that the entity paid during the period nor the expense payable that the entity is willing to pay. They are the interest expenses that occurred and should be recorded in the reporting period.
Based on the accrual principle. If all interest expenses that should be recorded in the period are paid, that means there will be no interest payable in the balance sheet.
However, if part of the expenses is paid, then the remaining amount should be reported in the balance sheet. In the income statement, IASB required its records separately because it helps the reader and investors to assess whether operating income could cover the interest expenses or that. And the ratio that is used to assess this is the time interest ratio.
The interest expenses are also used by most analysts to study the interest coverage ratio on how the entity could possibly handle the interest expenses by using profit before interest and tax.
If the interest expenses increase, the entity might face difficulty in paying by using profit. This is the main concern of investors. The increase or decrease of these expenses is affected by the income statement and balance sheet in the same direction as other expenses.
For example, the increase will be debit to income statements and credit to the balance sheet. And the decrease of their payment will be debited to the payable credit assets in the balance sheet.
Formula and Calculation
There are many factors that affect the expenses. Those include the principle and interest rate. The expenses can be calculated based on the following formula,
Interest Expenses = Principle * Interest Rate * Period
- The principle is the total amount that the entity owes its debtor
- Interest rate is the agreed rate charge to the entity by its debtor
- The period can be daily, weekly, monthly, and annually
Example:
For example, the entity borrows money from the bank to support its business operation. The principle of the loan is 500,000 USD and the interest rate annually 12%. The interest expense for the full year will be 60,000 USD.
During the year, the entity paid interest to the bank amount of 40,000 USD and at the end of the period, the interest payable amount was 20,000 USD.
Based on this example, the interest expenses that should be recorded in the income statement are 60,000 USD. And the amount that should be reported on the balance sheet at the end of the period is 20,000 USD.
It should be recorded in the current liability section if these payable are expected to be paid in the next 12 months. However, if part of them is expected to be paid in more than 12 months, then those parts are recorded in non-current liability.
Is interest expense an asset or liability?
Interest expenses are the non-operating expenses which not normally reported in the balance sheet of the entity’s financial statements. It is the P&L Item and presents only in the income statement and note to it if the nature and amount are material and the note is useful to the reader. Interest expenses are neither expenses nor liabilities.
Is interest expense a prepaid expense?
It is really depending on the company’s actual payment transactions which alight with the payment condition with the lender. If the company pays the interest in the coming period in advance to the lender, then the payment will be considered as assets that are classified as prepaid interest expenses.
And if interest expenses of the current period are going to pay in the next accounting period, then the company should recognize interest expenses in the income statement and interest payable on the balance sheet.
