Accrued interest refers to the interest that has accumulated on a loan, bond, or other financial instrument over a specific period but has not yet been paid by the borrower to the lender. It is an integral part of both accounting and finance and highlights the cost of borrowing over time which ensures that interest earnings are appropriately recorded and allocated to the period in which they are earned.
Imagine, that if money is lent to a friend, and you agree they’ll pay you back with interest after a month. The extra money (interest) that builds up day by day until your friend pays you back is what we call accrued interest. It’s like a meter running, adding up how much more they owe you for each day until the payment is made.
Accrued interest is a key concept in finance, banking, and investment. It is used to calculate the return on bonds and loans and it is important for investors who buy or sell fixed-income securities between interest payment dates. It ensures that investors receive fair compensation for the time they hold a bond, regardless of the payment cycle.
When a bond is bought between interest payment dates you will pay the seller the price of the bond plus the accrued interest which represents the interest earned from the last date of payment to the date of purchase. In the case of a loan, the accrued interest might be calculated daily but it is charged or paid monthly, quarterly, or annually.
Source: A to Z of Economics by Dr. NC Raghavi Chakravarthy