Interest payable is a liability representing money owed by a company. The figure is typically associated with borrowed money, such as a loan. If a company issues bonds, they may need to book interest owed to investors, and this figure goes on the company’s balance sheet for each accounting period. The number may change as the company pays off a portion of the interest based on an agreed-upon schedule with lenders or investors. Companies with multiple loans and issued bonds may have individual interest payable accounts for each one.
It is easy to confuse this concept with accrued interest. When a company owes interest in the form of a payable, the amount is usually fixed and paid at specific time periods. Accrued interest is money calculated on a dollar amount on an incremental basis. Companies may book accrued interest on the principal of a loan and then book it to their accounting ledgers. When posting accrued interest into the ledger, a company posts it to the loan account rather than a payable account.
A basic journal entry is necessary to record amounts into a company’s interest payable account. Two entries are common for this process. The first recognizes the liability; accountants debit interest expense and credit interest payable. This entry may be done well in advance of actually paying the interest if necessary. The second entry is necessary when the interest comes due; the accountant will debit the associated interest payable account and credit cash.
As a liability, interest payable reduces a company’s economic wealth. Economic wealth is the total assets less the total liabilities reported on the company’s balance sheet. An increase in payables indicates that the company owes more money to outside stakeholders. Without corresponding growth in the company’s assets, the payables will grow and reduce the company’s value. Debt associated with asset purchases will usually have a null effect on the balance sheet.
A company that continues to have its interest payable accounts increase can indicate higher use of debt in a firm. Many stakeholders see high debt use as negative for a company. Copious debt use often indicates a company is taking on more risk in hopes of earning higher income from future sales. If the sales fail to grow as expected, the firm with high debt may find itself on shaky financial footing. Reducing current debt and paying off the associated interest payable is the only way to unload this burden on the firm.