Many companies have interest-bearing assets, such as loans and investments, that generate a stream of income for the company. That interest can be categorized as either "interest receivable" or "interest revenue." These accounting terms have slightly different meanings.
Interest receivable refers to the interest that has been earned by investments, loans, or overdue invoices but has not actually been paid yet. Put another way, interest receivable is the expected interest revenue a company will receive. As long as it can be reasonably expected to be paid within a year, interest receivable is generally recorded as a current asset on the balance sheet.
Here are a few examples of interest receivable and how a company may account for them:
- A business loans an individual $100,000 at 5% annual interest, which will be paid back in full at the end of one year. If the company's balance sheet covers the first half of this period, then the $2,500 in accrued (but not yet paid) interest is recorded on the balance sheet. (Note: If a company believes there is a significant chance of non-payment of a loan, it may create a bad debt allowance to offset anticipated losses.)
- A business invests in bonds that pay interest twice each year, on March 1 and Oct. 1. The company's year-end balance sheet can list the interest that accrued after Oct. 1 as an asset, even though it won't be paid until March.
- A manufacturing company charges customers 1% interest per month on delinquent invoices. One customer's invoice has been delinquent for six months, accruing 6% interest. However, since there isn't a strong probability of collecting on this debt, it may not be a wise idea to count it as an asset.
Interest revenue has a different meaning depending on whether the accrual basis or cash basis of accounting is used. Under the accrual method, all accumulated interest is counted as interest revenue, even if it has not actually been paid yet. Meanwhile, under the cash method, interest is not recorded as revenue until it is actually paid.
For example, if a company has received $10,000 in interest payments during a particular quarter and accrued another $5,000 in owed interest, then it would report $15,000 in interest revenue under the accrual method. Under the cash method, only the $10,000 that was actually received would be reported as revenue on the income statement.
Want to learn more about how to start investing? Check out The Motley Fool's Broker Center and get started today.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at [email protected]. Thanks -- and Fool on!