Various Types of Transactions – Collection from Other Source of Revenue and Income, Interest Income (Part 4a)

Interest income is earned usually through deposits placements with financial institutions. Sometimes, it is also earned through lending of money to third parties (some countries have strict laws governing money lending activities). Interest is the price that borrowers pay for enjoying the resources (money) borrowed from the lenders. Usually, the interest rates are made known to the depositors by financial institutions at the time of deposits placement.

A very common practice by small businesses when comes to the timing of recording interest income the accounts is upon receiving the interest income. This is an example of cash basis of recording transactions instead of accrual basis of accounting. Please refer to my post: Cash Basis Vs Accrual Basis of Accounting for further illustrations on this topic

The double entry for recording interest income on cash basis is as follows: –

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank*

XXXX

Interest income

XXXX

*Business entities usually receive interest income directly in their banking accounts upon maturity or by way of cheques, instead of “hard cash”. Therefore, only cash at bank is shown and petty cash account is omitted.

For a detailed illustration on the recording of interest income on accrual basis, please refer to item No. 4, Interest Income, of my post: Cash Basis Vs Accrual Basis of Accounting .

According to International Accounting Standards (IAS) 18 – Revenue, the method used to calculate interest income is the effective interest method. Please refer to my post: Effective Interest? Simple Interest? Compound Interest? Nominal Interest? for further illustrations.

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