Interest receivable is the amount of interest that has been earned, but which has not yet been received in cash. The usual journal entry used to record this transaction is a debit to the interest receivable account and a credit to the interest income account. When the actual interest payment is received, the entry is a debit to the cash account and a credit to the interest receivable account, thereby eliminating the balance in the interest receivable account.
The interest receivable account is usually classified as a current asset on the balance sheet, unless there is no expectation to receive payment from the borrower within one year.
The accounting treatment of interest receivable may vary, as shown in the following two examples:
- Invested funds or loan. If a business has invested funds or extended a loan to a third party, it should accrue the amount of interest receivable on the funds or loan, up until the date of the balance sheet on which the interest receivable is being stated. If there is a significant risk of non-payment, it may be necessary to create an offsetting bad debt allowance for some portion of the interest receivable, which reduces the net amount of the receivable.
- Interest charge on invoice. A company may charge interest on an invoice that is overdue for payment. In this case, the odds of collection are low and the amount is likely to be small, so it may be acceptable for a business not to accrue the interest receivable. Instead, any interest paid can be recognized on the income statement when payment is received, which means that it is never recorded as interest receivable on the balance sheet. Conversely, if there is a history of receiving a material amount of interest income from this source, a business could accrue a best estimate of the interest receivable.