Interest Revenues

Interest revenues are the income a business recognizes for allowing others to use its money. They arise on loans, notes receivable, debt securities, finance leases, credit card balances, deposits held at other banks and customer accounts on which interest is charged. In the accounts the item may be labelled interest revenue, interest income or interest earned; the plural "interest revenues" often appears when a company has several sources, such as loans, securities and leases, reported together.

Where interest revenues appear depends on the business. For banks, credit unions, consumer finance firms and leasing companies, interest is their main revenue stream and is shown at the top of the income statement, followed by interest expense to give net interest income. For an ordinary trading or manufacturing company, interest revenues are incidental to operations and are reported in other income, below operating income.

Interest revenues accrue over time and are recognized in the period they are earned under accrual accounting. For a simple loan or deposit, the amount is principal times rate times time. For instruments bought or issued at a premium or discount, and for loans with origination fees, revenue is measured with the effective interest method, which spreads the fees, costs and any discount or premium over the life of the instrument.

For example, a lender makes a three-year, $100,000 loan at 7 percent and charges the borrower a $3,000 origination fee, while incurring $600 of direct costs to originate it. Under US GAAP (ASC 310-20), the net fee of $2,400 is not recognized as revenue when the loan is made; it is deferred and recognized as an adjustment to yield over the three years. The lender's interest revenues therefore include the $7,000 of contractual interest a year plus roughly a third of the $2,400 each year, measured precisely using the effective rate. The result is an effective yield of a little under 8 percent rather than 7 percent.

For financial institutions, interest revenues are analyzed in detail. The net interest margin compares net interest income with average earning assets, and banks disclose interest revenues by type of asset, such as commercial loans, residential mortgages, credit cards and investment securities. Changes in revenue are often broken down into the effect of volume, meaning more or fewer loans, and the effect of rate, meaning higher or lower yields. Periods of rising interest rates usually lift interest revenues quickly on variable-rate loans, while fixed-rate assets reprice more slowly.

Interest revenues should only be recognized on amounts that are expected to be collected. US banks generally place loans on non-accrual status when they are 90 days past due or when full collection is doubtful, reversing unpaid accrued interest and recognizing later receipts on a cash basis or as principal reductions. Under IFRS 9, interest revenue is normally calculated on the gross carrying amount of a financial asset, but once an asset is credit-impaired, known as stage 3, it is calculated on the amortized cost net of the expected credit loss allowance. IFRS also requires interest revenue calculated using the effective interest method to be presented as a separate line item.

Lessors recognize interest revenue on sales-type and direct financing leases using the rate implicit in the lease. Companies that sell goods on extended credit terms with a significant financing component must separate that component from the sale price under ASC 606 and IFRS 15, recognizing part of the consideration as interest revenue rather than sales revenue. On the cash flow statement under US GAAP, interest received is an operating cash flow. In the United States, interest revenues are generally taxable as ordinary income, except for interest on most municipal bonds, which is exempt from federal tax. Readers comparing companies should check whether interest revenues are shown gross or netted against interest expense, a common practice outside the financial sector.