DEFINITION of Accrual Rate
Accrual rates apply to a range of financial instruments including bonds, mortgages, credit cards, other types of loans and pensions. Accrual rates vary by instrument. For example, credit cards, bonds and mortgages often accrue daily interest, while student loans might accrue interest on either a daily or monthly basis. In the case of a six-month bond with interest payable semiannually, it will accrue daily interest during the six-month term until it is paid in full on the date it becomes due.
BREAKING DOWN Accrual Rate
Knowing the rate at which a financial obligation accumulates interest is important for understanding its price and ultimately its value. For example, in the case of bonds, since a bond’s price is the sum of all its future cash flows including principal and interest, the price at which it changes hands will include any interest accrued, but not yet paid. Similarly, when calculating the payoff amount for a mortgage or other debt, accrued interest amounts must be added to the principal balance outstanding.
Calculating An Accrual Rate
You can calculate the daily accrual rate on a financial instrument by dividing the interest rate by the number of days in a year — 365 or 360 (some lenders divide the year into 30 day months) and then multiplying the result by the amount of the outstanding principal balance or face value. Similarly, for obligations with monthly accrual rates, you would divide the annual interest rate by 12 then multiply the result by the amount of the outstanding balance. Normally accrual rates are positive values. But in extraordinary circumstances, such as during a period of negative interest rates, they might be negative.
Accrual rates are also used in non-financial contexts, such as for tracking vacation, sick days and other paid time off and pension balances, where they are used to calculate payments.
The concept of accruals also applies in Generally Accepted Accounting Principles (GAAP), accrual accounting. Under this method of accounting, earnings and expenses are recorded at the time of transaction, whether or not cash flows have been received or dispensed.