(II) is the company’s income, so it is reflected under the income statement for that period. Further in the income statement, the income is divided into two areas, i.e., income from operations and other income from interest income. Most companies come under the category of ‘other income’ except for those whose primary income is (II); in that case, the (II) will come under the category of income from operations. These sorts of short-term investments typically carry low yields, but it still enables the company to earn a return and offset losses from having “idle” cash. Interest income is the amount of interest earned on investments (that promise to pay interest) and/or compensation for agreeing to receive cash payments from customers at a later than normal date.

If the company’s income statement presents “Income from Operations” and “Other Income” separately, the classification of Interest Income will depend upon the primary operations of the business. It is computed by multiplying the principal amount by the interest rate for the period the money was lent. For example, the entity has a long-term deposit of the excess amount of cash into the bank with an interest rate of 12% annually. Banks can invest in various types of securities, such as government bonds, corporate bonds, and other debt instruments. Various indexed securities provide interest rates at a particular discount of the market rate. The balance to be paid is adjusted for inflation at the time of maturity.

Financial Intermediaries and Monetary Economics

Figure 1 highlights the striking fact that there is a near perfect negative one-to-one relationship between 4-quarter changes of the federal funds target and 4-quarter changes of the term spread (the plot uses data from 1987q1 to 2008q3). In this way, variations in the target rate have a one-for-one relationship with the slope of the yield curve. Since the term spread leads the NIM, shifts in the short-rate affect real activity because they change the profitability of financial intermediaries, thus shifting the supply of credit. Interest income journal entry is crediting the interest income under the income account in the income statement and debiting the interest receivable account in the balance sheet account. For example, the company might have an excess of funds that they earn from the operations and they might decide to invest that excess of funds to earn some more money by making a short-term or long-term deposit. The key difference between interest expense and interest income is that interest expense is the cost of borrowing money, while interest income is the money you earn from investing.

  • To calculate your interest income, you’ll multiply the interest rate by the principal.
  • Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
  • The remaining amounts are unpaid at the end of the year and are expected to be paid within 12 months.
  • For all entities not in the finance business, the (II) is the income from other sources.
  • Investors should consider ancillary revenue sources and expenses in addition to net interest income when evaluating a bank’s profitability.

In some situations, the term and conditions in the contract required interest to be paid for more than 12 months. Tammy teaches business courses at the post-secondary and secondary level and has a master’s of business administration in finance. In such cases, it is worth the time to locate the individual amounts broken out separately, so that each item can be referenced and projected in the forecast. Encyclopaedia Britannica’s editors oversee subject areas in which they have extensive knowledge, whether from years of experience gained by working on that content or via study for an advanced degree.


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. NII or net interest income is the difference between https://turbo-tax.org/interest-income-definition/ the income a bank earns from its lending activities and the interest it pays to depositors whereas NIM or net interest margin is calculated by dividing NII by the average earning assets. For the argument to go through a key assumption the term spread is determined in large part by the short-term interest rate.

When interest rates fall, bond holdings may gain in market value but new bonds purchased will carry lower yields. Moreover, the interest rate earned on cash for both periods will be set at 0.40%. A bank calculates its net interest income by subtracting the amount of interest-bearing liabilities from its interest-bearing assets. Interest income is usually taxable; the ordinary income tax rate applies to this form of income.

A simple example of interest income and how it’s reported

Interest income is recorded within the interest income account in the general ledger. This line item is typically presented separately from interest expense in the income statement. The amount of interest may have been paid in cash, or it may have been accrued as having been earned but not yet paid.

This applies to the trading or other kinds of company that its business model is not a financial institution. If the company is a financial institution, the interest income is the main income and it should be recorded in the income statement under the operating section. Finally, the net interest income of the profit and loss account should not be confused with the net interest margin on average total assets (NIM). The latter is an indicator of the profitability (expressed as a percentage) of a financial institution’s assets. Either way interest revenue is earned, it’s reported on the company’s income statement. In this lesson, we’ll also explore two ways of earning interest revenue, and explain how interest revenue is recorded on the income statement.

What Does Net Interest Income Mean?

However, the evidence from Asia is much less supportive of the hypothesis that foreign banks help to improve competition in the domestic system. In part, this could be a reflection of the limited extent to which Asian countries have embraced foreign bank participation relative to other regions. At the extreme are China and India, which severely limited the entry and activities of foreign https://turbo-tax.org/ banks. In the case of India, stochastic frontier analysis shows that foreign banks are less cost-efficient and productive than domestic banks. In part, this can be explained by the dominance of India’s state-owned banking sector. It also comes as little surprise that the profitability of the few foreign banks in China was lower than that of domestic banks from 1996 to 2004.

Interest Income Definition

A decline in the federal funds target leads to an increase in asset prices and, thus, an increase in the net worth of financial institutions. In response, levered financial institutions expand their assets by taking on additional leverage. Thus, the impact of changes in short-term interest rates is amplified via the balance sheet management of financial institutions. In many instances, high-volume traders will require faster and better trade execution. Direct access trading systems may provide for faster and potentially superior execution for such traders.

A bank’s interest income and interest expense will change as the market interest rate changes. The higher the spread the better the profitability position of the bank. Net interest income (NII)[1] is the difference between revenues generated by interest-bearing assets and the cost of servicing (interest-burdened) liabilities. For banks, the assets typically include commercial and personal loans, mortgages, construction loans and investment securities. NII is the difference between (a) interest payments the bank receives on outstanding loans and (b) interest payments the bank makes to customers on their deposits.

  • Contact your tax professional if you are unsure of your foreign income filing requirements.
  • Changes in interest rates can result in changes for the firm’s profit as well, for better or worse.
  • Our interpretation of this evidence is an economic mechanism that operates via the balance sheet management of financial intermediaries who borrow short and lend long.
  • In Excel, the standard method used to forecast either type of interest – interest income and interest expense – creates a “circularity” within a financial model, which we’ll discuss how to circumvent later in our modeling tutorial.

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