How does accrued interest affect the financial statements?

Accrued interest impacts financial statements by resulting in an increase in both expenses and liabilities. When interest is accrued, it signifies that an entity has incurred an obligation to pay interest on borrowed funds but has not yet made the payment. This situation is reflected in the financial statements as follows:

• On the income statement, accrued interest is recorded as an interest expense, which contributes to the overall expenses of the company, appropriately aligning with the matching principle by recognizing the cost in the period it was incurred, regardless of cash payment.

• On the balance sheet, the corresponding liability is established under current liabilities, indicating the obligation to pay this accrued interest in the future.

Thus, when interest is accrued, it increases expenses on the income statement due to recognizing the cost associated with borrowing and simultaneously increases liabilities on the balance sheet, as the company now has an outstanding obligation. This dual effect underscores the importance of recognizing accrued interest to provide an accurate financial position of the entity.