Accrued interest income

Definition: The income a company records under accrual accounting to recognize that the interest on money it has lent out has built up but not yet been received.

Example: LND Bank has loaned $1 million to DBT Corporation. The loan calls for DBT to pay 6% interest on the loan at the end of each year that the money remains lent to DBT. LND produces financial statements at the end of each quarter (ie: three months) of the year.

It would improper to ignore the benefit of the interest on the loan that has been building up (ie: accruing) just because it won’t be received until the end of the 4th quarter. The amount of interest that accrues each quarter is $1,000,000 * 6% * 1/4 year, or $15,000. The bank should make an entry which debits Accrued Interest Receivable for $15,000 and credits Accrued Interest Income for $15,000.

Investeach explains: The matching principle of accounting calls for companies to “match up” revenues with the expenses that are incurred to generate those revenues. The $1 million loan on which LND Bank is earning 6% interest per year came from customers who have deposited money at the bank. If LND is paying those customers interest while they keep their money at the bank, the accrual of the interest income would be necessary to recognize that the customer deposits enabled an interest-generating loan to be made!

Riddle me this:

1. How do we compute the amount of accrued interest on a loan?
2. What do you suppose will happen to the balance in the Accrued Interest Income account when the bank receives a check for accrued interest from a borrower?
3. Where do banks get money to loan out?