What is Interest Income?

Since this interest is not a part of the original investment, it is separately recorded. It is obtained by multiplying the principal amount by the interest rate for the period the money was lent.

Example

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Let us take an example of Bank of America. Revenue for a bank is different from the revenue of a non-financial company. Revenue for a bank comprisesNet Interest Margin is a popular profitability ratio used by banks which helps them determine the success of firms in investing in comparison to the expenses on the same investments. It is calculated as Investment income minus interest expenses (this step is referred to as netting) divided by the average earning assets.read more net interest incomeNet Interest IncomeNet Interest Margin is a popular profitability ratio used by banks which helps them determine the success of firms in investing in comparison to the expenses on the same investments. It is calculated as Investment income minus interest expenses (this step is referred to as netting) divided by the average earning assets.read more and net non-interest incomeNon-interest IncomeNon-Interest Income is the amount of revenue generated by a bank or other financial institution through non-core activities such as late payment fees, loan processing charges, and penalties, among others.read more.

  • For Bank of America, the total interest earned for the period was $57.5 billion.And the net interest income (total interest minus total interest expense) was $ 44.6 billion.

Types of Interest Income

There are two types – – Income from Operations and Other Income.

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#1 – Income from Operations

source: Bank of America SEC Filings

In cases where the company’s income statement shows Income from Operations and Other Income separately, the types of InterestTypes Of InterestFixed interest, variable interest, annual percentage rate, prime interest rate, discounted interest rate, simple interest, and compound interest are the most common types of interest.read more. Income depend upon the primary operations of the business. If the business is primarily making income from the interests like lending companies and financial institutions, this is taken as Income from Operations. As the example above notes, Bank of America’s core income is from “Interest.”

#2 – Non-Operating Income (Other Income)

source: Starbucks SEC Filings

If the core income does not come from interest, it is non-operating interest income and comes under other income.

All individuals, as well as organizations, have financial assetsFinancial AssetsFinancial assets are investment assets whose value derives from a contractual claim on what they represent. These are liquid assets because the economic resources or ownership can be converted into a valuable asset such as cash.read more from which they earn a variety of interests. The interest earned on these investments is taken as an income for the organization.

In most cases, the interest earned by the individual or the organization is reported in the income statement under Income from Operations or Other Income. The Internal Revenue System (IRS) has mandated that this interest be reported as taxable income.

Interest Income Accounting

How does Interest Income Works? (Individuals vs. Banks)

  • Suppose a person runs a big sized capital goodsCapital GoodsCapital goods are man-made assets used in the manufacturing process of a product. They are used to produce the final goods that people consume daily. They are one of the four factors of production- the other three being natural resources, labor, and entrepreneurship.read more business and has a balance of $10 50,000 in the company’s savings account. Now it must be understood that this $10 50,000 will not lie idle in the account until the owner decides to withdraw the entire amount.The bank in which the savings account is maintained loans this money to the other people and, in return, gets interested in this loan amount. The bank, in this situation, keeps a small percentage of the amount of $10 50 000 deposits in its hand. This system is also known as fractional banking.Now, these loans given by the bank can be long-term or short-term. Short-term loans are the overnight loans that are given to other banks. Since the bank is getting money on the person’s deposit, the bank then pays an amount as interest to the owner of the deposit so that the owner is motivated to keep the money in the account. So, for the entire year, the cash balance is the earning interestEarning InterestSimple interest (SI) refers to the percentage of interest charged or yielded on the principal sum for a specific period.read more paid by the bank at the end of each month.The bank must send out the details of how much interest it has paid the owner of the deposit in the bank account. Based on this statement, the deposit owner gets a clear idea of how much taxable interest income he has earned on the financial assets. So the owner’s business gets the interest payment, which is recorded in his income statementIncome StatementThe income statement is one of the company’s financial reports that summarizes all of the company’s revenues and expenses over time in order to determine the company’s profit or loss and measure its business activity over time based on user requirements.read more as income.

Interest Income Video

This article has been a guide to Interest Income. Here we discuss types of interest income – operating and non-operating (other income). Also, we discuss interest income accounting along with practical examples. You may learn more about basic accounting from the following articles –

  • Operating Income DefinitionTaxable Income FormulaIncome Summary AccountNon-Interest Income