When an organization has an interest-earning bank deposit or another interest-bearing receivable, it should account for any interest receivable at the period’s end by adjusting with a correct journal entry. This is because interest (income) is gained over time.
Similarly, the company’s total assets and total revenues on the balance sheet and income statement may be underestimated without correct journal entries at the end of the quarter.
If the firm’s interest-earning deposit or other receivable has the interest payment date at the month-end, there will be no interest receivable. The company will debit the cash account with the credit of interest revenue.
Interest Receivable – Definition
The amount of interest generated but not yet collected in cash is referred to as interest receivable. Many organizations will not record this amount because they believe it is insignificant.
Interest receivable is an asset on the balance sheet. It represents the amount of interest a company has earned on loans or investments but has not yet received.
For example, if you loaned $1,000 to a friend and she paid you $50 in interest at the end of each year, her interest would be $550 ($50 x 5 years).
By debiting the interest receivable account and crediting the interest revenue account at the period end, the corporation can modify the interest receivable journal entry.
The interest receivable is a balance sheet asset, whereas the interest revenue is a revenue statement item. Similarly, this journal entry raises total assets and income by the same amount.
When the corporation gets the interest payment, it can create a journal entry by debiting the interest account and crediting it.
The interest receivable that the corporation recorded in the prior period adjusting entry will be removed after this journal entry.
The most typical journal entries used to record interest receivable are:
- a debit to the interest receivable account
- a credit to the interest income account.
When the interest payment is received, the entry is a debit to the cash account and a credit to the interest receivable account, resulting in zeroing the interest receivable account balance.
As seen in the following two cases, the accounting treatment might differ:
Interest is added to the invoice:
A business may charge interest on an invoice that is past due. Because the chances of collection are slim and the amount is anticipated to be minimal, it may be appropriate for a company to forego accruing interest.
Instead of being recorded as interest receivable on the balance sheet, any interest paid might be reported on the income statement when payment is received.
A firm might accumulate the best estimate of the interest receivable if there is a history of receiving significant interest revenue from this source.
Invested funds or borrowed funds:
If a company has invested money or issued a loan to a third party, the amount of interest due on the funds or loan should be accrued until the balance sheet date on which the interest due is disclosed.
If there is a high chance of nonpayment, an offsetting bad debt allowance for a portion of the interest receivable may be necessary, lowering the net amount of the receivable.
For example, on January 1, 2021, Khai Ltd. lends $60,000 to the firm Xero Ltd. at a monthly interest rate of 0.45 percent. The note has a 24-month maturity period, after which the firm Xero Ltd. will repay the principal.
However, according to the arrangement, Xero Ltd. will pay interest on the first day of each month beginning February 1, 2021, and continue until the note matures.
What is the interest receivable journal entry:
- When Khai Ltd. made the month-end adjustment entry on January 31, 2021
- When the firm Khai Ltd. received the first interest payment on February 1, 2021
January 31, 2022
At the January 31 adjusting entry, the firm can make the following journal entry for interest receivable of $270 (60,000 x 0.45 percent):
February 1, 2022
When the firm gets the interest payment on February 1, 2021, it can make the following journal entry to remove the interest receivable reported in the prior period by adjusting the threshold:
It’s worth noting that, in reality, when the interest receivable is tiny (due to a low balance of notes receivable or a low-interest rate on deposit), the firm usually only records the interest when it gets the payment. As a result, some tasks that provide little value to the firm can be reduced.
If this is the case, the cash received will be recorded with the interest revenue. As a result, there will be no interest receivable journal entries.
The interest receivable journal entry is recorded when the company records the interest earned from lending money to its customers. This is common in most banking institutions and could include the interest earned from savings account deposits.
To record interest receivable, the first thing to do is open up your general ledger, and then under Loans, make a new account that notes Interest Receivable as of the name.
It’ll appear like any other account. After you set up the initial account, it’s simply going into each transaction and recording how much interest has accrued on this specific loan so far.