The most widely accepted and simple definition of interest income is the revenue that is generated from invested savings made by an individual or a company.
Interest income is the revenue earned by a lender for use of their funds or an investor on their investment over a period of time. This revenue is taxable and reported in the ‘finance income’ section of an income statement.
This could be as simple as funds held in a bank account which generate interest over time.
Virtually all individuals and organisations hold financial assets which earn some form of interest. The interest that is paid to the individual or company is regarded as a form of income.
Interest income is calculated with the accrual method in accounting. Put simply, this means that that interest is recorded while it is being earned, not when it is paid out.
Calculation of accrued interest is dependent on the effectual interest rate, the compounding period and the investment balance.
Putting the explanation into a practical example is the easiest way to understand how the concept works.
A small to medium sized business maintains a balance of EUR 50,000 in its company savings account. Banks do not simply hold onto money and sit on it.
When you deposit money into a bank, either physically or digitally, the bank loans out that money to other parties, or embarks on its own investment ventures with it.
The concept is called fractional banking. Just as you are earning interest by depositing funds in the bank, the bank will charge interest to its customers who have taken out investment loans or mortgages.
The bank will hold onto some of the funds you have deposited, but will use most of it for its own business activities. Should you wish to withdraw your cash, the bank will free up your savings from its own reserves and liquid assets.