What is interest expense?
The cost of borrowing recorded for the period. A regional HVAC shop books this month's interest on the equipment loan here, even if the bank has not been paid yet.
Definition
Interest expense is the cost of borrowed money that belongs to this period. On the books, this is an Income Statement cost, not the loan balance and not the principal you pay down.
A regional HVAC shop books this month's charge on the equipment loan here. Paying the bank later does not move the cost into a different month.
Accrual books record the days the loan was outstanding. Cash-basis books may wait until the payment leaves the bank.
This cost is the period's borrowing charge. It is not the truck that was financed, and it is not the keep-the-shop-open costs that sit above operating income.
Where it shows up
P&L: Located below operating income.
Balance Sheet: Related to the loan and the interest still unpaid.
Cash flow: Decreases when interest is paid, reported cash from operating activities decreases.
See also: Notes Payable · Other Income And Expense · Interest Coverage Ratio
When you look at your Income Statement, this cost sits under the operating-income subtotal. Service revenue and the costs of running the shop sit above that subtotal.
When the figure is high, the shop borrowed more, a rate went up, or more days accrued. When it is low, a smaller balance or a shorter month brought the charge down.
The Balance Sheet does not keep this period's cost after the close. The loan sits in notes payable, and any unpaid charge sits in accrued interest payable.
On the Statement of Cash Flows, the payment is the cash event. Cash from operating activities falls when the interest leaves the bank.
Operating expenses are the keep-the-doors-open costs of the shop. Those stay above operating income; this borrowing charge sits below.
A line of credit can produce the same kind of cost when the shop draws. The meaning does not change: it is still this period's charge for borrowed money.
How it works
The shop borrows on a note or a line, and the lender charges for the days the money is out. That charge belongs to those days, not to the day the check is written.
At month end the books debit this cost and credit accrued interest payable. The Income Statement takes the charge now; the unpaid amount waits on the Balance Sheet.
When the shop later pays the bank, the books debit accrued interest payable and credit cash. That payment clears the unpaid charge; it does not create a second cost.
Stay with this period's borrowing charge when you read the line. A principal payment reduces the loan; it does not belong here.
Do not treat the whole monthly ACH as this cost. The loan amortization schedule splits each payment into principal and interest.
A debt schedule lists each loan, its rate, and what is still owed. This line is only the period's interest piece from that list.
After the month closes, this cost is part of the period's leftover. Next month starts the count again from zero.
Example
Ridge Air HVAC is a regional shop with an equipment loan on a new van and a set of recovery machines. Month-end interest on that loan is $1,200, and the bank has not been paid yet.
The shop records:
Debit: Interest expense $1,200
Credit: Accrued interest payable $1,200
This cost hits the Income Statement, and accrued interest payable (a liability) rises by $1,200. Cash has not moved.
Service revenue this month is $62,000. Operating income is unchanged by the $1,200; the leftover after this charge is $1,200 lower.
When Ridge Air pays the bank next week, cash falls and the accrued balance falls. The $1,200 cost stays in this month, where the days of borrowing sat.
If the same loan had $400 of principal in that payment, the $400 would reduce notes payable. Only the $1,200 belongs on this line.
Common mix-ups
Interest expense is not the same as the loan balance. The loan is what you still owe; this line is the period's charge for using that money.
Interest expense is not the same as a principal payment. Principal reduces the note; this line is only the interest piece.
Interest expense is not the same as cash leaving the bank. Accrual books record the days first; the payment can land in a later week.
Related terms
- Notes Payable: Formal loan balances owed to a bank or other lender.
- Loan Amortization Schedule: The payment-by-payment breakdown of a loan into principal and interest.
- Accrued Interest Payable: Interest that has built up on debt but has not yet been paid.
- Other Income And Expense: Non-operating items reported below the operating income line.
- Interest Coverage Ratio: Operating earnings measured against interest expense.
- EBITDA: Earnings before interest, taxes, depreciation, and amortization.
- Line Of Credit: A revolving loan the business can draw on and repay as cash needs change.
- Debt Service Coverage Ratio: Cash available to cover scheduled principal and interest payments.