Definition: Interest income is the revenue earned by a lender for use of his funds or an investor on their investment over a period of time. This revenue is typically taxable and reported in the other income section of the income statement.
What Does Interest Income Mean?
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What is the definition of interest income? Nearly all individuals and organizations hold financial assets that earn some variety of interest. The interest that is earned on those investments over a period of time is considered income. In nearly every case, interest income earned by an entity is reported below the other income section of the income statement, and the Internal Revenue Service (IRS) requires the interest to be reported as taxable income.
Based on the accrual method of accounting, interest is recorded as it is earned, not necessarily as it is paid (assuming risk of receiving payment is low). Accurately accounting for interest requires a detailed understanding of the investment terms and conditions. Specifically, the calculation of accrued interest is dependent upon the interest rate, the compounding period, and the investment balance.
A simple example of interest income and how it’s reported
Let’s say you operate a medium sized business and you maintain $1,000,000 balance in the company savings account. This money does not sit idle in the account until you choose to withdrawal it. The bank loans this money out to other people and collects interest on the loan. This is called fractional banking. The bank only holds a small percentage of your original $1,000,000 deposit on hand.
These loans could be long term in nature, but they are typically overnight loans to other banks. Since the bank is making money on your deposits, they typically pay you a small amount of interest to encourage you to leave the money in your account. Throughout the year, your cash balances earn interest that the bank pays out at the end of each month.
Each year, the bank is required to send you and the IRS a 1099-INT reporting how much interest was pay to the bank account. This statement outlines the amount of taxable interest income earned on the financial assets held at the bank and is used to prepare tax returns.
It’s important to note that there are two sides to each interest transaction. Your business receives an interest payment. Thus, it recognizes income on its books. The bank sends and interest payment. Thus, it recognizes an expense for the period.
Summary Definition
Define Interest Income: the amount of interest earned on an investment.
