In business, the term “interest” can refer several concepts: interest paid or earned on lent money, an person’s economic stake in commercial activities, contractual participation of company executives/shareholders in affiliated companies (such as suppliers), and more.
Other interest is a term used in financial reporting to denote the above concepts when they are not significant enough to merit individual explanation in reporting, and instead are grouped together.
This article focuses on other interest paid & earned on money lent. Later in the article I address other economic interests of a company or its stakeholders that require disclosure in financial reports. The goal in disclosures is provide transparent information to potential investors and government authorities.
Both are important to understand how businesspeople use the term “other interest.”
What is other interest on loans?
Other interest on loans refers to interest obligations paid (or earned) on multiple loan agreements a company holds, the values for which are not sufficiently large to present on individual lines, or are not similar enough to be grouped together as a single business activity.
How to Find Other Interest in Financial Reports (10-Ks)
If you look at a public company’s financial statements, you will see lines called “other interest,” though finding them requires some investigation. Take Microsoft’s 2021 Income Statement for example as found in it’s 2021 10-K filed with the SEC:
We see a line called “Other Income, net.” Since this is a “net” number, it means Microsoft has either taken the net of multiple incomes, or taken the net of similar incomes and expenses. We need to look closer to find out.
On the page, hit Control + F to open the search feature and type “other income” to see an explanation. Doing so brings us to this excerpt:
We see here two lines called “Interest and dividends income” and “Interest expense.” These are loan interest earned and paid, but the amounts are not significant enough to merit individual treatment. And if Microsoft did outline all of them, it would be an unreasonable amount of information for investors to process.
Types of Other Interest on Loans
So we know Microsoft has other interest payments AND earnings. But what do these lines represent? In most cases, there is a description available. In Microsoft’s case, we see a description below the table:
The other interest earnings come from fixed-income securities (usually bonds), while the interest expense relates to payments on long-term loans.
This description is not detailed, so we need to use industry knowledge of interest-bearing instruments to “guess” what these items may be. Here are a number of different types of instruments that could be the underlying source of other interest (and whether they can be income or expense)
In all cases, an interest-bearing instrument can be an other interest expense. However, only a few debt instruments can function as income for a company. This is because many of these instruments are unique to banks. A Certificate of Deposit, for example, is always issued by a bank.
Moreover, most equity instruments can function as income or expense. This is because equity instruments are for the most part participations in companies.
It is therefore easier to narrow down the options on “other interest from income” than for expenses. In the case of Microsoft, the interest earned on “fixed-income securities” is almost certainly from corporate bonds it has issued.
Examples of Other Interest on Loans
Let’s look at a specific example of and other interest expense. Imagine you own a hardware company with big loan agreements made with Bank of America for purchasing factories to produce your hardware. You list these loans independently in the company filings as “Loans with Bank of America.”
However, you also have several small loans with various regional banks that you use to purchase raw materials in bulk and pay back as you make sales. One of these loans is with the Bank of Georgia (fictional) for $250,000. The interest rate is fixed at 2% monthly, and the length of the loan is 2 years.
You make monthly payments for the first 8 months, then a bullet payment in month 8 because you sell all the inventory of raw materials. There is an early cancellation fee with Bank of Georgia of $25,000. Here’s what the interest payment would look like in your yearly filings:
While you can see the full loan schedule here, the only number you will show in the financial statements is $(2,855). But remember, you have multiple loans with local banks to fund the purchase of raw materials. Imagine three others amount to $(3,567), $(4,231), and $(1,856). In this case, they will all be grouped together, and you will only show $(12,509) as a single line in your financials statements.
Importantly, the early cancellation fee of $25,000 will NOT appear as other interest in the statements. Instead, it will be booked as “bank fees” or “other bank fees.” In this way, the full picture of financing activities grouped in “other interest” does not always show a transparent view of the company. Because the values are so small, however, it is not material information to investors.
LIBOR & Other Interest Rate Indexes
It’s important to recognize the difference between “other interest” and “other interest rates.” Other interest rates have little-to-nothing to do with the presentation of company finances. They refer to industry standard rates that lenders use to benchmark their own rates.
For example, the London Inter-Bank Offered Rate (LIBOR) refers to the rate at which the big banks in London would lend money to each other. This is often used as the standard for low-interest agreements such as those made between entities in the same group.
These are often called “other interest rates” because they refer to the finance community’s attempt to standardize the interest market. While they do in practice, banks are never obligated to follow these standards with commercial or retail clients.
While other interest rates can be used as the applicable rates on “other interest” loans, they are not used by default. Don’t confuse the two!
Other Interest: Sensitive Economic Requiring Disclosure
A material transaction between two parties that benefits either party outside the scope of the transaction, such as a consultant who also serves as a board member, is said to involve “other interest.”
For example, imagine an executive in one company holds shares in a second company, and the second company acts as a supplier to the first. The executive has an “other interest” in the transaction, since she benefits from it beyond the commercial terms between the two companies, as outlined in the contract.
A common form of other interest is executives acting also as consultants. Lawinsider.com defines other interest as holding a position in a business such as an officer, director, trustee, partner, proprietor, executor, employee, or a position of management, or acting as a consultant, agent or representative therefore in any capacity.
To be more specific, other interests are relevant in relationships with people who meet the definition of “related party.” The International Financial Reporting Standards (IFRS) standard 24 defines a related party as a person or an entity that is related to the reporting entity:
- A person or a close member of that person’s family is related to a reporting entity if that person has control, joint control, or significant influence over the entity or is a member of its key management personnel.
- An entity is related to a reporting entity if, among other circumstances, it is a parent, subsidiary, fellow subsidiary, associate, or joint venture of the reporting entity, or it is controlled, jointly controlled, or significantly influenced or managed by a person who is a related party.
As the second point shows, people aren’t the only ones who can have other economic interests. In a group of companies, one entity may provide services to another at a very inexpensive price (i.e below the market). This could result in negative net earnings for the first company, reducing its taxable income.
When the two companies are “rolled up” at consolidation, the low earnings in company one would offset earnings in company two, reducing the taxable income. The companies therefore have an “other interest” in that transaction than the simple provision of services. In almost all jurisdictions, this is not permitted.
Conflict of Interests
In simple terms, other interests between related parties are a problem when they present a conflict of interest. You don’t have to be a specialist in reporting standards to understand when a conflict of interest exists. Good common sense is usually enough.
Just ask yourself, “is some person or some company benefiting from a transaction more than what the contract shows?”
Other Interest as Off-Balance Sheet Items
Another area where other interest is important is off-balance sheet items. Off-Balance sheet items are obligations or assets that do not directly concern the entity and are therefore not included in its financial statements but would potentially need to be included in the future.
For example, and entity that acts as a guarantor for another entity will not record the loan obligation on its accounts. However, in the case that the guarantee defaults on the loan, the guarantor would include the loan as an obligation (because it will have to pay).
Off-balance sheet items can be “other interest” because they constitute economic stake, even if it does not fall meet the traditional sense of the term.
Conclusion
If you found this article helpful, feel free to check out more free content on data, finance, and business analysis at the AnalystAnswers.com homepage!
