In simple context an accrued means something that is increased over a period of time.
An accrued interest is a type of interest earned on a particular investment but the investor has not collected it.
In accounting terminology, accrued interest is the amount of interest that has been incurred as of a specific date on a financial obligation but has not yet been paid out.
In reference to the bond investment, accrued interest usually means the amount of periodic interest that bond generate gets accumulated since the last time the interest payment was made.
Another example of accrued interest is the interest on savings account balance that accrue on a daily basis but is credited to the beneficiary account at the end of every month.
Accrued interest is mostly associated with bond investments and they are calculated basis the mentioned components namely:
Face value of the bond, the coupon rate of the bond and the time horizon of the accrual period.
Accrued interest = Face value of the bond *(Coupon rate / 365) * Accrual period
For example:
Suppose the face value of the bond is Rs. 1,00,000 along with the coupon rate @ 5% and accrual period of 63 days, then the accrued interest is
1,00,000 * 5%/365 * 63 =Rs. 863.01
Accrued interest is an important point to consider at the time of purchasing or selling a bond. Bonds offer the owner compensation for the money they have lent in the form of periodic interest payments.These interest payments also referred to as coupon payments are paid semi-annually .
However, bonds are not only the financial instruments where the interest payments are accrued. On a normal loan as well the interest gets accrued wherein the principal amount remains the same . Interest accrues and is due to the lender before a regular payment date.
On the closure of the transaction, the amount of interest paid by the borrower is calculated by the below formula:
Loan amount * (Interest rate / 365) * Accrual period.
Therefore accrued interest is the interest that is added to the face value of the bond to compensate the bondholder in regards to the time value of money.
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