Recognition of Interest Income

Interest income refers to the interest that is accrued over time through a business's investments in financial instruments. For example, interest earned on corporate bonds is counted as interest income. Certain other liabilities that others owe to the business can also produce interest and be counted as interest income. Under a cash basis, interest income is recognized when it is paid; under an accrual basis, interest income is recognized when it is earned.

Cash basis accounting records costs and revenues on the accounts when the cash for them is either paid out or received. As such, while interest income might have been earned before its actual time of payment, an accountant working under the assumptions of cash basis accounting cannot recognize it until the business is paid the money.

Accrual basis accounting records costs and revenue on the accounts at the time of their occurrence. For example, although payment might not be received for interest income until multiple months in the future, an accountant working under accrual basis will recognize interest as income in each period until the interest-paying instrument no longer produces interest.

Recognizing revenue, including interest income, in accrual basis accounting is dependent on two factors. First, the amount must have been earned, meaning that the economic transaction has been completed. Second, the amount must be realizable, meaning that there is no reason to think that it cannot be collected. Therefore, interest income is recognized at the end of each period so long as the issuer of the interest-paying instrument does not seem likely to default.

At the end of each accounting period, the amount of interest earned is recognized as income, which is then recorded as an account receivable on the business's balance sheet. At the time of the income being paid, the amount paid is written off of the accounts receivable ledger and recognized as cash or whatever cash equivalent was used to pay the business.