Accrued interest is the interest earned on a bond between coupon payment dates and paid when the buyer gets the bond from the seller. This guide explains the meaning of accrued interest, how it is calculated, and how it is taxed for bond investors.
Most of the time, you don’t buy a bond directly from the issuer. Instead, you purchase it in the secondary market, often through an exchange or an online bond platform, and usually between two coupon payment dates. When you do this, you may notice that the amount you pay is higher than the bond’s quoted price. That extra amount is called accrued interest.
So, is accrued interest something you pay or money you earn? How is it calculated? How does it work? In this blog, you will learn everything from what accrued interest is to how it is taxed, so you clearly understand what you are paying and why.
What is Accrued Interest?
Accrued interest is an interest that has accumulated on a bond but has not yet been paid. In simple words, whenever a bond is bought and sold in the secondary market, the buyer has to compensate the seller for the interest that has been accumulating between coupon payment dates.
This happens because a bond continues to earn interest every day between two coupon payment dates, even though the actual interest is paid periodically. And when you purchase a bond in the secondary market, you are stepping into an instrument that has already been accruing interest since the previous coupon date. If the seller were to transfer the bond without recovering this accrued portion, they would forgo the interest income earned during their holding period up to the sale date.
Accrued interest ensures that interest income is allocated fairly between the seller and the buyer. The seller receives compensation for the interest earned while holding the bond, and the buyer, in turn, receives the full coupon payment on the next interest date.
To fully gauge the role of accrued interest in bond pricing and cash flows, it is useful to compare it with other forms of interest that are defined and recognized differently.
Accrued Interest vs Other Types of Interest
Accrued interest is often confused with other forms of interest such as simple and compounding interest. Let us put all 3 types of interest side-by-side for better understanding.
| Parameter | Accrued Interest | Simple Interest | Compound Interest |
| Features | Builds daily between payment dates and reflects interest earned but not yet paid or received. | Calculated only on the original principal, resulting in a fixed and predictable interest amount. | Calculated on both principal and accumulated interest, causing returns to grow exponentially over time. |
| Example | You buy a bond 30 days after the last coupon date and pay the seller interest for those 30 days, even though the next coupon hasn’t been paid yet. | You invest ₹1,00,000 at 8% simple interest for one year and earn a fixed ₹8,000, with no interest earned on interest. | You invest ₹1,00,000 at 8% compounded annually; after one year it becomes ₹1,08,000, and the next year interest is earned on ₹1,08,000, combining both principal and interest earned. |
Once you know how to distinguish accrued interest from other types of interests, the next step is understanding how the accumulated interest in accrued interest is actually calculated between two coupon dates.
How is Accrued Interest Calculated?
Accrued interest can be calculated by using the formula given below:
Accrued Interest = (Principal Amount × Interest Rate) × (Days since last coupon/days in a year)
Here is how the individual components of the formula look.
- Principal amount: This amount refers to the original sum on which the interest is calculated. For example, if you invest ₹1,00,000 in a bond, that becomes your principal.
- Interest rate: The annual rate of interest agreed upon, expressed as a percentage. For example, 8% per year would be written as 0.08 in calculations.
- Time period (days since last coupon): The number of days for which interest has accumulated but not yet been paid. If 45 days have passed since the last payment, that becomes your time period.
- Days in period: The total number of days considered for one complete interest cycle. In the Indian bond market, this is typically 365 days (Actual/365 day count convention), while some corporate bonds or international markets may use 360 days (30/360 convention).
To see how accrued interest plays out in a real bond purchase, let’s apply this formula to a simple secondary market scenario.
Accrued Interest Calculation on a Bond
Imagine you have bought a bond worth ₹1,00,000 with a 3-year maturity that pays 8% annual interest. While the interest on this bond is paid semi-annually, here is how you can find out the interest accrued after just 45 days have passed.
Using the formula:
Accrued Interest = (1,00,000 × 0.08) × (45 / 365)
= ₹986
After 45 days, you have earned approximately ₹986 in interest, even though you haven’t received the payment yet. This is what “accrued interest” captures. It ensures your earnings (or obligations, if you’re the borrower) are recorded accurately, even between payment dates.
Now that we understand how accrued interest is calculated for bond investments, the next big question is, what about taxes? Is accrued interest taxable, and if yes, how is it treated?
Is Accrued Interest Taxable?
Yes, accrued interest is taxable in the hands of the person who earns it, not the person who pays it. When a bond is sold between coupon dates, the seller typically receives the accrued (or “broken period”) interest for the days they held the bond since the last coupon date.
In India, if you hold bonds as an investment, interest income is taxed under “Income from Other Sources” at your applicable slab rate. However, if you are a frequent trader, this may be treated as “Profits and Gains from Business or Profession”.
For the buyer, the accrued interest paid at purchase is not a separate taxable income. Instead, the buyer receives the full coupon on the next payment date (including the portion that economically belongs to the seller), the coupon interest is typically offset by the buyer on the accrued interest paid; so, the same interest is not taxed twice.
Note: Under Section 193 of the Income Tax Act, TDS is generally not applicable on interest from listed dematerialized bonds. However, TDS may apply to unlisted bonds or certain specific instruments at a rate of 10%. So, it’s best to reconcile what shows up in your AIS/TIS with your bond statement before filing.
Accrued Interest in Everyday Finance: Loans, Credit Cards, and More
Accrued interest affects you outside of the world of bond investing. It plays an important role in many financial products you use on a daily basis.
Take loans, for example. If you were to take a home loan or a personal loan, the interest on it would accrue everyday on the outstanding balance, even though you are suppose to pay it through a fixed EMI once a month. This is why the interest component of your EMI changes over time and why prepayments reduce future interest costs.
Credit cards work on the same principle. If you do not pay your total outstanding balance by the due date, interest starts accruing daily from the transaction date. What eventually shows up as a single finance charge on your statement is actually the accumulation of daily interest over that period.
The same mechanism applies to overdrafts, delayed bill payments, and even income tax dues. If you miss a tax payment deadline, interest accrues for every day of delay until the amount is settled. In all these cases, accrued interest ensures that the cost of using money is accurately captured based on time, not just payment dates.
Final Thoughts
Accrued interest matters because it changes how you think about timing, not returns. Many bond investors focus on coupon rates and yield but ignore when they enter or exit a position. Accrued interest quietly reminds you that time always has a cost or a value in fixed income investing. Once you factor this into your decisions, you start treating them as time-sensitive contracts, where entry dates influence cash flows alongside credit quality and bond maturity. This shift in perspective leads to clearer pricing decisions, fewer surprises, and a more disciplined approach to bond investing overall.
