Accrued interest is the interest payable on fixed-income securities, such as bonds. Capitalized interest has different meanings, depending on the financial context in which you are using the phrase. For example, the Department of Education capitalizes interest for unsubsidized student loans, while businesses capitalize interest for the cost of self-constructed assets.
A fixed-income security is an investment that pays you at regular intervals until the security reaches its maturity date. Bonds are an example of a fixed-income security. For example, the issuers of these securities make interest payments to investors every 30 days, or once every six months. The interest accrues between payment dates, but isn’t paid until the actual date arrives. The issuer then makes one payment for all the months the bond accrued interest. For example, if your payment dates are once every six months, the issuer pays you six months worth of accrued interest in one lump sum on each payment date.
When you receive a federal student loan, it is either subsidized or unsubsidized. While you are in school, the government doesn’t charge you interest on subsidized loans, but does charge you interest for unsubsidized loans. You can opt to pay your interest on your unsubsidized loans while you are in school. But you choose not to, the government then capitalizes your interest payments by adding them into your principal loan amount.
Student Loan Example
For instance, assume you have a $5,000 unsubsidized loan your first year of school with interest payments of $10 per month. You opt not to make these payments throughout the year, making your total interest charges $120. In your second year, your principal loan balance becomes $5,120. The government will then begin charging you interest on your original loan of $5,000 plus the capitalized interest amount of $120.
Capitalized Interest Accounting
Capitalized interest in accounting works much in the same way as the capitalized interest for student loans. When a company obtains a loan to pay for a long-term asset it is a self-constructed asset, rather than one bought from an outside party, it capitalizes the interest on the loan by adding the interest to the total cost of the project. The cost of the loan for constructing the asset, plus the capitalized interest is what the company reports as the total cost of the project on its balance sheet.