Interest is a fee charged by a lender to a borrower for lending money. For a business, interest earned usually arises on money deposited with a financial institution such as a bank, and can be simple or compound interest. The interest is usually paid on a regular basis, such as monthly, quarterly, or annually, and can be used to increase profitability and support growth.
Additionally interest earned is usually reported in the financial statements in the accounting period in which it is earned under the accounting categories of interest income, interest revenue, or investment revenue.
It is important to realize that the amount of interest depends on the amount invested, the interest rate, and the length of time over which it is invested.
Interest Earned Journal Entry
To illustrate suppose a business has deposited 10,000 with a bank earning 5% simple interest. In this case at the end of the year, the interest is 10,000 x 5% = 500. Subsequently if the interest is deposited in the bank account of the business, the interest income double entry journal to post this to the accounting records is as follows.
| Account | Debit | Credit |
|---|---|---|
| Cash | 500 | |
| Interest income | 500 | |
| Total | 500 | 500 |
The Accounting Equation
The Accounting Equation, Assets = Liabilities + Owners Equity means that the total assets of the business are always equal to the total liabilities plus the equity of the business. It is important to realize that this is true at any time and applies to each transaction. For this transaction the accounting equation is shown in the following table.
In this case one asset (cash) increases representing money received in respect of interest earned. This increase is balanced by the increase in owners equity. The credit to the income statement for the interest income increases the net income which increases the retained earnings and therefore the owners equity in the business.
Interest earned is an important financial concept for a business, as it provides a source of passive income. For businesses, interest on investments and surplus funds can help to increase profitability and support growth.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.