Most companies incur interest expenses for the debt finance they acquire. Sometimes, however, they may also provide funds to other entities. It usually occurs when a company invests in financial assets or securities. In that case, they may also get interest income from the underlying security.
What is Interest Income?
Interest income refers to the amount generated from interest receipts through investments. It occurs when a company provides finance to another entity. Subsequently, that entity pays the company a return for its investment. This return comes in the form of interest income. However, it only occurs when the type of finance provided is debt.
The concept of interest income applies to all investors, including companies, individuals, and other entities. Usually, it depends on the invested amount and a fixed rate set by the borrower. In some cases, the lender also dictates that rate. Either way, the interest income they receive will equal the product of those figures. However, other factors can also impact that income.
What is the difference between Interest and Dividend Income?
Investors may receive income from their investments in various forms. Usually, these fall under either interest or dividend income. Differentiating between the two is highly crucial for several reasons. Usually, interest income comes from debt instruments or securities. It is when an entity lends its money to another. In exchange, it only receives the interest income from the borrower.
However, dividend income differs from interest income. Dividend income comes from equity instruments rather than debt. Apart from the dividend, these instruments may also carry ownership rights to the underlying company. This income also depends on the profits the company makes. On the other hand, interest income is usually a fixed amount and doesn’t relate to those profits.
What is the accounting for Interest Income?
The accounting for interest income is straightforward. It involves increasing income in the records while also increasing assets. However, this process may involve two stages due to the accrual concept in accounting. The first stage requires companies to realize an interest income as soon as it occurs. For this stage, the journal entries will be as follows.
Once companies receive the interest in their bank account, they must record it. Although this process does not impact the interest income recognized, it is a part of the process. This process constitutes the second stage of accounting for interest income. At this stage, the journal entries will include the following.
How to calculate Interest Income?
Companies can calculate their interest income in a few straightforward steps. These include the following.
- Take the principal amount lent to the borrower.
- Multiply that amount with the interest rate on the security or debt instrument.
- Multiply it with the total number of years the lender will keep providing the interest income.
For example, a company provides $10,000 to a borrower at a 10% interest rate. The maturity date for the loan occurs after five years. In this case, the total interest income from the agreement will be $5,000 ($10,000 x 10% x 5 years).
Interest income refers to the money generated from lending funds to another entity. This income comes from debt instruments or securities. However, it differs from dividend income, which relates to equity instruments. The accounting for interest income is straightforward and involves two stages. Companies can calculate the total interest income from investment using a few simple steps.
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