CFM80170 - Old rules: loan relationships: authorised accounting methods: accruals basis: accruing interest

Allocating payments: accruing interest

This guidance applies to periods of account beginning before 1 January 2005

Where a company pays simple interest at regular intervals, the straight-line method of accrual can be an acceptable method of allocating payments for both debtors and creditors. However, where the interest intervals are uneven, or the rates change, the apportionment of the interest charge is less straightforward. The relevant UK accounting standard FRS 4 states the costs should be allocated to give a constant rate on the amount outstanding. The economic accruals method is the most appropriate method to achieve this - see CFM22030 for more detail.

Example: borrower

AG Ltd issues a £500,000 5-year bond. No interest is payable in Years 1, 2 and 3. £30,000 interest is payable in each of Years 4 and 5 - a rate of 6%.

AG Ltd must recognise its obligation to pay interest at a later date. Although no interest is payable in the earlier years, the payments relate to the whole 5-year period. To conform with an authorised accruals method, AG Ltd must bring an amount into its accounts in each accounting period.

Example: lender

KL Ltd purchases the £500,000 5-year bond issued by AG Ltd. Although it will not receive interest in earlier years, it must recognise its right to receive interest in its accounts in each accounting period.

KL Ltd could use any acceptable method for accruing interest - economic accruals, straight-line or rule of 78. It is most likely to use the economic accruals method, as this more correctly matches the income to the balance outstanding.