Interest payable: definition, how to calculate and examples
By Indeed Editorial Team
Published 5 September 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Interest payable is an account a company or an individual keeps to record the unpaid interest they owe at a particular time. Companies and business owners often use it to determine their liabilities on the balance sheet, helping them to create financial statements. If you're considering keeping track of this metric, understanding how to calculate it is essential to your success. In this article, we discuss what interest payable is, examine how it compares to interest expense and demonstrate how to calculate the debt with practical examples of how to do so.
What is interest payable?
Interest payable (IP) is an account a company or individual keeps that records the unpaid interest they owe at a particular time. This term can also apply to unpaid debts or interest expense prior to the date on the balance sheet. Any expense or interest accrued after the date on the balance sheet is not part of the IP. Therefore, it's usually a company's current liability, and you can refer to it as accrued interest. You can find accrued interest in a separate account on the balance sheet bearing accrued interest liability.
IP is a vital part of financial statement analysis because a high-IP shows that the entity is defaulting on its debt obligations. Likewise, stakeholders typically presume a high-IP is likely to affect the business's liquidation capacity. Its liabilities are usually formed from bond instruments, debts, capital leases the entity owes and other payable liabilities.
IP vs interest expense
Interest expense and IP are both debts an entity owes, but they differ in many ways. Some differences between the two are:
Their meaning: IP is the amount of interest on capital leases and debt an entity owes to its lease providers or lenders, as recorded on the balance sheet date. Interest expense is the total cost an entity incurred in interest on borrowed funds.
Type of account: IP is a liability account typically listed on the balance sheet, while interest expense is a cost or expense account you would find on an income statement. This is because business owners and companies debit their interest expenses and credit their IP.
Amount: IP is the amount of interest an entity has yet to pay the lender, while interest expense is a cost or an amount an entity may or may not have paid to the lender. For example, an entity can have an interest expense of £35,000 a year but IP of only £2,916.66 (£35,000 / 12).
How to calculate: You can calculate IP based on the amount of interest you have yet to pay using the formula Principal x Rate x Time. In contrast, you calculate interest expense based on the total amount of unpaid debt over a reporting period.
How to calculate IP
Below are steps you can follow when calculating a company's unpaid interest:
1. Identify the notes payable
The first step to calculating the IP is to determine what the notes payable are. Notes payable are long-term debts showing the amount an entity owes its financier(s). Most new business start-ups or companies look for financiers who can help them establish or expand their business. For example, a business owner considering expanding their business may borrow the sum of £30,000 from a friend. Knowing what their note payable is can help them to calculate their IP.
2. Change the interest rate to a decimal
The next step is to find out what the interest rate is. An interest rate is the amount of interest due or charges due to a lender in proportion to the amount borrowed, which is usually a percentage of the principal. After identifying the interest rate, change it into a decimal. For instance, if the interest rate from a financier was 6%, it becomes 0.06 in decimal form. This makes it easier to calculate the rate in the formula later.
3. Determine the period to calculate
To calculate the unpaid interest, it's important to decide the period to calculate. To determine the period to calculate, there are certain rules to consider. When calculating IP with a quarterly interest period, divide by four. If you're calculating the interest period daily, divide by 365. If it's over a set of months, divide by 12.
For example, imagine a financier gives someone a loan of £30,000 at the interest rate of 6% for a period of five months. In this scenario, you would divide by 12, where 12 is the bottom numeral.
4. Find your periodic interest rate
After identifying the calculation period and converting the interest rate to a decimal, the next step is to divide the interest rate by the period you just established. This calculates the periodic interest rate. Using the example mentioned above, the fraction would be the following:
0.06 / 12 = 0.005%
This means the regular interest rate is 0.005%.
5. Calculate the payable interest
To determine IP, multiply the periodic interest rate by your outstanding notes. From the above example, the IP is the following:
0.005 x £30,000 = £150.00
Therefore, the monthly unpaid interest on the loan from the financier is £150.00.
Examples of IP
The following are typical examples of how to calculate IP:
The following example demonstrates how a company might determine how much unpaid interest they have for an account:
Mega Groove Company needs £200,000 cash as soon as possible. To meet this need, they issue a six-month 15% note payable to a financier on 1 October 2021 and receive £200,000 cash from them immediately. They expect the note payable to be due by 30 March 2022. Therefore, the financier expects Mega Groove to pay back the principal amount of debt and the interest of 15% on the due date. These dates include:
a. Calculate the amount of unpaid interest on 31 November 2021.
b. Calculate the amount of unpaid interest on 31 February 2022.
a. The interest for the first month is:
£200,000 x 0.15 x 1/12 = £2,500
To calculate the total amount of IP on 31 November 2021, they add the interest for October to the interest for November:
£2,500 + £2,500 = £5,000
Alternatively, they can calculate the IP in November 2021 by the following:
£200,000 x 15% x 2/12 = £5,000
b. On 31 February, which is the end of the first quarter of 2022, their IP account will show a credit balance of £12,500:
£200,000 x 0.15 x 5/12 = £12,500
The following is another example depicting how a company might determine how much interest they could accumulate over a period of time:
On 7 January, So Clean Company, a concentrated detergent manufacturer, borrowed £40,000 to open a new factory location. So Clean Company agrees with their lender to repay the £40,000 with an annual interest rate of 10% plus an eight-month interest with their payment due on 7 October.
By 7 February, So Clean Company has an IP amount of £333.33 or:
(£0,000) x (0.1 x 12 months)
They recorded the following liabilities in their balance sheet:
Notes payable: £40,000
By 7 March, So Clean Company has an IP amount of £666.66 or:
(£40,000) x (0.1 x 1/12 months) x (2)
Therefore, their current March balance sheet includes:
Notes payable: £40,000
Unpaid interest: £666.66
By 4 April, So Clean Company's interest rate is £999.99 or:
(£40,000) x (0.1 x 1/12 months) x (3)
Their April balance sheet includes:
Notes payable: £50,000
Unpaid interest: £999.99
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