Interest expense is calculated as the interest rate multiplied by the amount of the outstanding principal of the debt. Defined by Investopedia, interest expense is the cost incurred by an entity on borrowed funds.
An example calculation of an interest expense calculation is $50,000 x .07 x 3 = $10,500, according to the Strategic CFO. In this example, which does not take into consideration compounding, the principal is $50,000, the interest rate is 7 percent and the duration of time is three years, and so the calculated interest expense is $10,500.
On the income statement, the interest expense denotes the interest accrued during the period covered by the financial statements. Investopedia explains that it does not represent the amount of interest paid toward the principal during the period covered by the financial statements. Not all interest expenses are tax-deductible. Knowing the purpose of the loan is crucial to determining whether or not the interest expense is tax-deductible. It is also important to consider local tax rules.
According to Investopedia, interest expense is often a line item on a balance sheet because there is often a difference in timing of the interest accrued and the interest paid. If the amount accrued has not yet been paid, it appears as a Current Liability on the balance sheet, whereas if the interest expense is paid in advance, it appears as Current Assets.