128 Government Finance Statistics Manual 2014
therefore, from an accrual recording perspective, are
reductions of the debtor’s existing liability, part of
which was created by the accrued interest expense.
6.65 From a cash recording perspective, periodic
debt service payments, recorded in the Statement of
Source and Uses of Cash, can be distinguished as in-
terest payments (“coupons” or “coupon payments”) or
principal payments. When using the cash basis of re-
cording, interest payments are recorded as an expense
transaction when such cash fl ows occur. In this case,
only principal repayments will reduce the debtor’s li-
ability. Th e amount initially advanced or borrowed is
also known as initial principal.
6.66 In macroeconomic statistics, interest is calcu-
lated according to the debtor approach.^22 According
to this approach, interest is equal to the amounts the
debtors will have to pay to their creditors over and
above the repayments of the amounts advanced by
the creditor. For fi xed rate instruments, this approach
assumes that interest expense is determined for the
entire life of a fi nancial instrument by the conditions
set at inception of the instrument. Interest accrual
is therefore determined by using the original yield-
to-maturity. A single eff ective yield, established at
the time of security issuance, is used to calculate the
amount of accrued interest in each period to matu-
rity. Th e accrual of interest should be calculated by the
compound interest method.^23
6.67 In the simplest case, a sum of money is bor-
rowed, periodic payments are made equal to the inter-
est expense incurred during the previous period, and
at the end of the contract, a fi nal payment of inter-
est is made together with a repayment of the original
amount borrowed. Th e amount of interest expense in-
curred each period is equal to the interest rate stated
in the contract multiplied by the amount borrowed.
6.68 When the end of the reporting period does
not coincide with a periodic payment, the total liabil-
ity at the end of the period will include some amount
of interest incurred but not yet paid. As each period
passes, the amount of principal outstanding increases(^22) Th ere are three approaches for defi ning and measuring interest
for traded debt instruments: debtor approach, creditor ap-
proach, and acquisition approach (see the BPM6, paragraphs
11.52–11.53).
(^23) Examples of the calculation of interest can be found in the PSDS
Guide, Box 2.3, and 2013 EDS Guide, paragraphs 2.65–2.77.
as interest expense is incurred. Any periodic payment
of the accrued interest reduces the principal to the
amount originally borrowed.
6.69 Some debt instruments may have a grace
period^24 during which no interest payments are to
be made. For those debt instruments for which the
contract requires the accrual of interest during the
grace period (i.e., the relevant interest rate that applies
during the grace period is greater than zero), the ac-
crual of interest should be recorded as specifi ed in the
contract, increasing the value of the principal. On the
other hand, if the debtor can repay the same amount
of principal at the end of the grace period as at the
beginning (i.e., the relevant interest rate applied to
the grace period is zero), no interest costs accrue dur-
ing the grace period.^25 Th is remains true even if the
rate of interest applied in a second and/or subsequent
time period is adjusted (e.g., there is a step up), so
that the fi nal yield is roughly similar to what it would
have been under normal conditions over the total life
of the instrument. Th is treatment applies to loans and
deposits but not to debt securities.
6.70 Loans with step-up interest should accrue at
the contractual rate of interest for any period and not
at the internal rate of return^26 of the loan. On the other
hand, interest on debt securities with step-up interest
should accrue at the original yield-to-maturity rate
over the life of the security.^27
6.71 Certain fi nancial instruments, such as short-
term bills and zero-coupon bonds, do not require
the debtor to make payments to the creditor until
the liability matures. In eff ect, the debtor’s liability
is discharged by a single payment covering both the
amount of the funds originally borrowed and the in-
terest accrued and accumulated over the entire life
of the liability. Instruments of this type are said to be
discounted because the amount initially borrowed
is less than the amount to be repaid. Th e diff erence
(^24) Th e grace period is the period from the disbursement of the
loan until the fi rst payment due by the debtor.
(^25) If a prepayment fee or a penalty for prepayment is paid, it
should be classifi ed as a service fee under use of goods and services
(22), and not as interest.
(^26) See the 2013 EDS Guide, paragraph 2.98 and Box 2.4, for a
discussion on internal rate of return.
(^27) Th e original yield-to-maturity rate is the rate at which the
present value of future interest and principal payments equals
the issue price of the bond—that is, the yield of the security at
issuance.